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info@reason.org (Reason Foundation)http://www.pjdoland.com/chai/?v=0.1The Facts About Spending Cuts, the Debt, and the GDPhttp://www.reason.org/news/show/the-facts-about-spending-cuts-the-d
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<p><em>Editor's Note: Reason <a href="/archives/archives/people/veronique-de-rugy/all">columnist</a> and <a href="http://mercatus.org/">Mercatus Center</a> economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p>Raising the debt limit might put off a downgrade disaster in August, but that still isn&rsquo;t enough&mdash;as <a href="http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&amp;blobcol=urldata&amp;blobtable=MungoBlobs&amp;blobheadervalue2=inline%3B+filename%3DUnitedStatesofAmerica_AAAA_7_14_11.pdf&amp;blobheadername2=Content-Disposition&amp;blobheadervalue1=application%2Fpdf&amp;blobkey=id&amp;blobheadername1=content-type&amp;blobwhere=1243932109521&amp;blobheadervalue3=UTF-8"> Standard &amp; Poor&rsquo;s recent warning</a> made clear. Perhaps the most important shot not heard around the world was S&amp;P&rsquo;s <em>other</em> admonition: Namely, that the U.S. bond rating will be downgraded in three months, if not sooner, unless we do something about government spending. Beyond raising the debt limit, S&amp;P laid out clear criteria for avoiding a downgrade: 1) reduce the debt by about $4 trillion; 2) agree to a credible plan within three months; and 3) guarantee that this newfound fiscal discipline will actually stick.</p>
<p>If S&amp;P isn&rsquo;t bluffing, then lawmakers should get serious about reducing the debt-to-GDP ratio, and they should do it quickly. But how do we achieve such a task?</p>
<p><strong>Myth 1:</strong> <em>You cannot reduce the deficit to an appropriate level without also raising taxes.</em></p>
<p><strong>Fact 1:</strong> <em>Spending cuts are the most effective way to reduce the debt-to-GDP ratio.</em></p>
<p>We are not the first nation to struggle with a dangerous debt-to-GDP ratio, and thankfully, the academic world has already produced great insights into what can be done to reduce this ratio without hurting the economy.</p>
<p>Take the work of Harvard&rsquo;s <a href="http://www.economics.harvard.edu/faculty/alesina/files/Large%2Bchanges%2Bin%2Bfiscal%2Bpolicy_October_2009.pdf"> Alberto Alesina and Silvia Ardagna</a>. They examined 107 efforts to reduce the debt in 21 OECD nations between 1970&ndash;2007. Their findings suggest that tax cuts are more expansionary than spending increases in the cases of a fiscal stimulus. Also, they found that spending cuts are a more effective way to reduce the debt-to-GDP ratio:</p>
<blockquote>
<p>For fiscal adjustments we show that spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns. In fact, we uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions. We also investigate which components of taxes and spending affect the economy more in these large episodes and we try to uncover channels running through private consumption and/or <a href="http://www.nationalreview.com/corner/272455/policy-implications-sp-warnings-veronique-de-rugy"> investment</a>.</p>
</blockquote>
<p>As you can see in this chart, in cases of successful fiscal adjustments&mdash;defined by the cumulative reduction in debt-to-GDP ratio three years after fiscal adjustment greater than 4.5 percentage points&mdash;spending as a share of GDP fell by about 2 percentage points while revenue also fell by half a percentage point (left bars). On the other hand, unsuccessful fiscal adjustment packages&mdash;cumulative increases in debt-to-GDP ratio&mdash;were made of smaller spending reductions (only 0.8 percentage-point reduction) and large revenue increases (right bars).</p>
<p><img src="http://reason.com/assets/mc/jtaylor/RCdebt1.jpg" border="0" width="547" height="407" /></p>
<p>The IMF <a href="http://www.imf.org/external/pubs/ft/spn/2010/spn1012.pdf">found similar results</a> and reports that fiscal adjustment on the requisite scale of what we need today is actually not unprecedented:</p>
<blockquote>
<p>During the past three decades, there were 14 episodes in advanced economies and 26 in emerging economies when individual countries adjusted their structural primary balance by more than 7 percentage points of GDP. Several economies were also able to sustain large primary surpluses for five or more years afterwards, though the record is more mixed in this regard.</p>
</blockquote>
<p>For those who are not ideologically inclined toward austerity measures, it is key to remember that this research is consistent with&nbsp;<a href="http://elsa.berkeley.edu/%7Ecromer/RomerDraft307.pdf">the work</a> of former Obama Council of Economic Advisers chairman Christina Romer and her economist husband, David Romer, which shows that increasing taxes by 1 percent of GDP for deficit-reduction purposes leads to a 3 percent reduction in GDP. In fact, Alesina and Ardagna discuss the work of Romer and Romer&nbsp; starting on page five of their paper.</p>
<p><strong>Myth 2:</strong> <em>Lawmakers facing economic catastrophe forget about politics and adopt measures that address genuine fiscal issues.</em></p>
<p><strong>Fact 2:</strong> <em>Politicians rarely put politics aside. Historically, four out of five fiscal adjustments were primarily comprised of tax increases&mdash;and were unsuccessful.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/RCdebt2.jpg" border="0" width="538" height="397" /></p>
<p>Following and building on Alesina and Ardagna&rsquo;s work, <a href="http://www.aei.org/docLib/20101227-Econ-WP-2010-04.pdf">a new paper</a> by Andrew Biggs, Kevin Hassett, and Matthew Jensen of the American Enterprise Institute studies fiscal adjustments covering over 100 instances in which countries took steps to address their budget gaps. Their results are consistent with those of the Harvard economists; expenditure cuts outweigh revenue increases in successful consolidations. Moreover, their work shows that even in a time of crisis (or especially in a time of crisis), lawmakers tend to adopt policies for the sake of politics. Countries in fiscal trouble generally got there through years of catering to interest groups and pro-spending constituencies (on both sides of the political aisle), and their fiscal adjustments tend to make too many of the same mistakes.</p>
<p>As a result, failed fiscal consolidations are the rule rather than the exception. Indeed, 80 percent of the fiscal adjustments Biggs, Hassett, and Jensen studied were failures. The United States cannot afford to follow this pattern.</p>
<p><strong>Myth 3:</strong> <em>We have had higher debt-to-GDP ratios before so we shouldn&rsquo;t worry now.</em></p>
<p><strong>Fact 3:</strong> <em>We should worry. The debt-to-GDP ratio actually underestimates the size of the government&rsquo;s real liabilities.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/RCdebt3.jpg" border="0" width="487" height="331" /></p>
<p>As government debt and deficits have swollen, we often look to the past for guidance. From that point of view, history appears to be reassuring, since several advanced countries have had debt-to-GDP ratios much higher than the one we have now. The United States after World War II had a public debt/GDP ratio of roughly 110 percent, while Britain&rsquo;s was 250 percent. In fact, the UK&rsquo;s national debt has averaged almost 100 percent of GDP since its creation in 1693. France's public debt was about 280 percent of GDP at the end of World War II. And yet neither of these countries defaulted. So why should we worry?</p>
<p>Two main reasons: First, while our debt is big now, it&rsquo;s only going to get bigger in the coming years. This year, the debt held by the public is $9.7 trillion, which is roughly 69 percent of GDP. According to the Congressional Budget Office, it will reach 200 percent in 2037--if the economy doesn&rsquo;t collapse first (which it likely will). These projections aren&rsquo;t surprising considering that the president&rsquo;s budget doubles the debt held by the public from $9 trillion today to $18 trillion in 2021.</p>
<p>Second, the debt-to-GDP ratio actually underestimates the scale of our debt problem. Here is why:</p>
<p><em>1. Intragovernmental debt.</em> This $4.6 trillion of debt is money that the federal government owes to its various trust funds. In other words, it&rsquo;s a liability to the government but an asset to the trust funds, so in accounting term it&rsquo;s zeroed out. However, over time the programs will redeem the IOUs as they need the money to fund benefits. As that happens, the intragovernmental debt decreases but debt held by the public increases. Eventually, this $4.6 trillion will be converted into public debt.</p>
<p><em>2. Unaccounted liabilities.</em> There exists a broad range of liabilities that are debt, yet are not captured in the debt-to-GDP ratio. To take one example, the Financial Statement of the United States values the government&rsquo;s civil-service pension liabilities (that is, the contractual claims on government accumulated to date by civil servants) at $5.7 trillion. That amount is not captured by the debt-to-GDP ratio. A share of this $5.7 trillion will be paid for by IOUs included in the intragovernmental debt, which we know will be converted into public debt. In addition, the unfunded share of this liability will have to be paid for with more debt, which isn&rsquo;t accounted for in the debt/GDP metric. The Financial Statement of the United States shows another $1.5 trillion of such liabilities, including payments due to government-sponsored enterprises.</p>
<p><em>3. Unfunded liabilities.</em> There is a balance of $39 trillion in unfunded liabilities over 75 years for programs such as Social Security and Medicare.</p>
<p>While we can&rsquo;t add all these numbers up because it would be the equivalent of comparing oranges to apples (some of these numbers represent the net present value of beneficiaries&rsquo; future claims on the government), considering them in context still helps to illustrate why the debt-to-GDP ratio underestimates how much present and future debt has been accumulated over the years. Hopefully, this also helps illustrate why the current debt-ceiling debate shouldn&rsquo;t just focus on Treasury&rsquo;s ability to pay our bills today, but must focus on our overall debt problem.</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> is a senior research fellow at the <a href="http://mercatus.org/">Mercatus Center</a> at George Mason University.</em></p>1011988@http://www.reason.orgFri, 29 Jul 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts About the Debt Ceilinghttp://www.reason.org/news/show/the-facts-about-the-debt-ceiling
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<p><em>Editor&rsquo;s</em> <em>Note: Reason <a href="/archives/people/veronique-de-rugy/all">columnist</a> and <a href="http://mercatus.org/">Mercatus Center</a> economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>If a deal is not reached by August 2, the U.S. will default on its debt.</em></p>
<p><strong>Fact 1:</strong> <em>The Treasury Department can prioritize payments in order to avoid a default.</em></p>
<p>The Treasury Department is due to pay off $30 billion in maturing short-term debt. But we also know that the Treasury has the ability to prioritize its payments and pay that particular $30 billion out of the $172 billion it collects in tax revenue. As the Bipartisan Policy Center has calculated, after paying $30 billion in interest payments in August, Treasury could, if it ceased all other functions (see page 13 of <a href="http://www.bipartisanpolicy.org/sites/default/files/Debt%20Ceiling%20Analysis%20report.pdf"> this document</a>), also pay for Social Security, Medicare, unemployment benefits, and payments to defense contractors. Technically speaking, there is no need to default in the absence of a debt ceiling agreement.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/debtceiling1.jpg" border="0" width="529" height="395" /></p>
<p>This is not an ideal solution and it entails some significant risks (mainly timing difficulties), but it could be done if necessary.</p>
<p>In addition, the Treasury could <a href="http://www.washingtonpost.com/wp-srv/politics/fact-checker/Mercatus-Debt-Limit-MoP.PDF"> sell some of its assets</a> in order to pay the bills. That&rsquo;s an expensive option at this point, since it would probably mean selling them at a low price, but these are not normal times and a fire sale beats a default.</p>
<p><strong>Myth 2:</strong> <em>If the debt ceiling isn&rsquo;t raised the government won't be able to pay Social Security benefits.</em></p>
<p><strong>Fact 2:</strong> <em>There are approximately $2.6 trillion dollars in the Social Security Trust Fund. Those assets can be used to pay benefits. Furthermore, there is already trillions of dollars of interagency debt that counts toward the $14.29 trillion debt limit. Treasury Secretary Timothy Geithner could convert that interagency debt into publicly-held debt, preventing not only a technical default but also preventing any delay in government payments.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/debtceiling2.jpg" border="0" width="523" height="381" /></p>
<p>President Barack Obama has suggested that if the Treasury prioritized payments in order to prevent default on the debt, it might do so on the backs of seniors by not sending out their Social Security checks. This is a particularly troubling rhetorical move by the White House. As the president and his advisers know, there are ways for the government to pay these benefits&mdash;messy ways, yes, but still viable&mdash;in the absence of a debt-ceiling agreement. That&rsquo;s what the president should be saying rather than trying to scare seniors.</p>
<p>According to a Bipartisan Policy Center <a href="http://www.bipartisanpolicy.org/sites/default/files/Debt%20Ceiling%20Analysis%20report.pdf"> report</a>, incoming revenue on August 3 will amount to $12 billion. At the same time, the government is scheduled to spend some $32 billion&mdash;most of it in the form of Social Security checks. How do we make up the difference?</p>
<p>First, remember how Social Security works. Starting now, the difference between payroll-tax revenue and Social Security benefits is made up by redeeming the IOUs in the Social Security Trust Fund. In order to pay back this IOU, Treasury has to borrow the money, which increases the debt held by the public by the same amount. In other words, if Treasury were to redeem the needed Social Security bonds and issue new marketable Treasury bonds to make good on them, it would be a one-for-one swap.</p>
<p>There is a potential glitch, however, having to do with whether Treasury has the authority to use payroll tax money to pay benefits rather than to &ldquo;<a href="http://www.nationalreview.com/corner/271758/president-needs-stop-scaring-seniors-veronique-de-rugy">invest</a>.&rdquo; According to <em>Washington Post</em> &ldquo;Fact Checker&rdquo; Glenn Kessler, the Treasury has <a href="http://www.washingtonpost.com/blogs/fact-checker/post/can-president-obama-keep-paying-social-security-benefits-even-if-the-debt-ceiling-is-reached/2011/07/12/gIQA9myRBI_blog.html"> done it before</a>:</p>
<blockquote>
<p>There is a technical wrinkle involving the fact that payroll taxes that are collected are supposed to be immediately turned into Treasury securities, but there could be ways around that, such as putting the monies in a noninterest bearing account, as during the 1985 debt crisis.&nbsp;&ldquo;Although some of the Secretary&rsquo;s actions appear in retrospect to have been in violation of the requirements of the Social Security Act, we cannot say that the Secretary acted unreasonably given the extraordinary situation in which he was operating,&rdquo; the General Accounting Office later concluded....</p>
</blockquote>
<blockquote>
<p>Still, during the 1996 debt limit crisis, Treasury Secretary Robert Rubin announced that Treasury did not have sufficient funds to pay Social Security benefits. Congress rushed to pass a special law that said the Social Security benefits did not count against the debt limit. Was this designed to pressure the Republican-led Congress, or had even a shrewd operator like Rubin run out of options? However, Congress later that year passed a law, 121-104, that codified Treasury&rsquo;s authority to use Social Security trust funds to pay benefits and administration expenses in the event a debt ceiling is reached, which could give the administration the authority they need in the current crisis.</p>
</blockquote>
<blockquote>
<p>The Congressional Research Service has also explored this question in a series of reports this year. The answer is unfortunately inconclusive and buried in a footnote: &ldquo;Under normal procedures Treasury pays Social Security benefits from the General Fund and offsets this by redeeming an equivalent amount of the trust funds&rsquo; holdings of government debt. In order to pay Social Security benefits, and depending on the government&rsquo;s cash position at the time, Treasury may need to issue new public debt to raise the cash needed to pay benefits. Treasury may be unable to issue new public debt, however, because of the debt limit. Social Security benefit payments may be delayed or jeopardized if the Treasury does not have enough cash on hand to pay benefits.&rdquo;</p>
</blockquote>
<p><strong>Myth 3:</strong> <em>The Treasury cannot use the Social Security Trust Fund to delay a default past August 2.</em></p>
<p><strong>Fact 3:</strong> <em>While the Treasury cannot use money from the Social Security Trust Fund, it can &ldquo;disinvest&rdquo; from other trust funds to pay for benefits.</em></p>
<p>Treasury can &ldquo;disinvest&rdquo; from some of its trust funds. Here&rsquo;s <a href="http://www.narfe.org/departments/home/print.cfm?ID=2480">how it works</a> according to the legislative director of the National Active and Retired Federal Employees.</p>
<blockquote>
<p>Each day, the U.S. Treasury takes in several billion dollars for federal trust funds. For Social Security, these dollars come in the form of employer and employee payroll taxes. Federal employee and Postal Service contributions to the CSRDF [Civil Service Retirement and Disability Fund] also inject cash into the Treasury. Usually, this cash is immediately invested in nonmarketable government securities&mdash;to remain available to finance future benefits. But if a debt limit breach appears imminent, the Treasury Department could &ldquo;underinvest&rdquo; this revenue as it arrives. The trust funds would be given a temporary IOU that does not count against the debt ceiling, and the withholdings would be used to pay off the government&rsquo;s cash obligations until an increase in the debt ceiling could be settled.</p>
</blockquote>
<blockquote>
<p>The Treasury Department could also make cash available from the trust fund by &ldquo;disinvesting&rdquo; some of the money used to buy government bonds. Under this approach, bonds held on behalf of trust funds would be converted to cash earlier than normally needed. Like the &ldquo;underinvestment&rdquo; option, cash from this transaction would be used to pay federal obligations on a temporary basis.&nbsp;&nbsp;&nbsp;</p>
</blockquote>
<blockquote>
<p>The disinvesting approach is a temporary accounting device that would help maintain the Treasury&rsquo;s cash flow.</p>
</blockquote>
<p>According to the Government Accountability Office, the use of &ldquo;disinvestment&rdquo; to pay for benefits has been used during a previous debt-ceiling crisis:</p>
<blockquote>
<p>In the past, Treasury has taken a number of extraordinary actions such as temporarily disinvesting securities held as part of federal employees&rsquo; retirement plans to meet the government&rsquo;s obligations as they came due without exceeding the debt limit, until the debt limit was raised.</p>
</blockquote>
<p><img src="http://reason.com/assets/mc/jtaylor/debtceiling3.jpg" border="0" width="532" height="390" /></p>
<p>In fact, it happened during the last big debt-ceiling crisis in 1995-1996. According <a href="http://www.gao.gov/products/AIMD-96-130">to the GAO</a>, Treasury managed to remain technically under the debt ceiling and incurred about $138.9 billion in additional debt that normally would have been subject to the ceiling by disinvesting $46 billion in Civil Service fund securities in November 1995 and February 1996. The Treasury also suspended the investment of $14 billion in fund receipts in December 1995 and exchanged about $8.6 billion in Civil Service fund securities for Federal Financing Bank securities.</p>
<p>These actions, of course, are nothing more than short-term budget gimmicks. But they would allow the U.S. to avoid defaulting on the debt. Once these options are exhausted, however, there will be nothing left to do but raise the debt ceiling or dramatically cut government spending.</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> is a senior research fellow at the <a href="http://mercatus.org/">Mercatus Center</a> at George Mason University.</em></p>1011933@http://www.reason.orgMon, 18 Jul 2011 18:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Red/Blue Paradoxhttp://www.reason.org/news/show/the-redblue-paradox
<p>We hear it all the time: Red states are for limited government; blue states are for heavy spending. While this may be true when it comes to broad political preferences, it&rsquo;s false as measured by patterns of federal spending.</p>
<p>When you compare the 50 laboratories of democracy after sorting them based on how their citizens voted in November 2008, only 10 Democratic-voting states are net recipients of federal subsidies, as opposed to 22 Republican states. Only one red state (Texas) is a net payer of federal taxes, as opposed to 16 blue states. One blue state (Rhode Island) pays as much as it gets.</p>
<p>Political scientists have been wrestling with this apparent paradox for years. One explanation sometimes offered is that the red states, on average, have smaller populations. In &ldquo;Political Determinants of Federal Expenditure at the State Level,&rdquo; published by the journal <em>Public Choice</em> in 2005, two University of Alabama at Tuscaloosa economists, Gary Hoover and Paul Pecorino, note that residents of low-population states have more per capita representation in Congress, since every state, regardless of population, has two senators. That edge, Hoover and Pecorino argue, translates into more federal handouts. The results are conspicuous in the case of homeland security grants, where small, rural, relatively low-risk states get much more money per capita than urban states that face bigger terrorist threats.</p>
<p>But red-state lawmakers&rsquo; ability to bring home the bacon isn&rsquo;t the main reason for the paradox. Red states, on average, are also lower-income states. Because of the progressive federal income tax, states with higher incomes pay vastly higher federal taxes. These payments are unlikely to be matched by federal spending directed back into those states.</p>
<p>This transfer of tax dollars from the states to the federal government is net of tax deductions, including deductions for state taxes ($50 billion in fiscal year 2012) and mortgage interest ($100 billion). As the former U.S. Treasury economist Martin Sullivan showed in the March issue of <em>Tax Notes</em>, the mortgage interest deduction overwhelmingly benefits high-income states. If it weren&rsquo;t for that deduction, blue states would be even bigger net payers than they are today.</p>
<p>The mortgage benefit is somewhat mitigated by the alternative minimum tax (AMT), which disallows certain tax breaks, including the personal exemption and the deductions for state and local taxes. About half of the people paying the AMT in recent years live in one of four states: California, Massachusetts, New Jersey, and New York. Between them, those four states account for almost a quarter of the nation&rsquo;s population.</p>
<p>Why would voters in red states elect lawmakers who promise them small government when they benefit disproportionately from federal handouts? Why would voters in blue states elect lawmakers who support policies that redistribute their income to red states?</p>
<p>One possible explanation is that the voters are misinformed. According to this theory, the people who benefit the most from federal spending simply don&rsquo;t understand how much money they receive; they assume their tax dollars are subsidizing others when in fact they are the ones being subsidized. People in rural states might be convinced that liberal urban Northeastern jurisdictions get large subsidies for entitlements, welfare, and industry bailouts, while failing to understand how much their own states benefit from agricultural and welfare spending. They may mistakenly equate life in a low-density environment with self-sufficiency. Subsidies and welfare from the federal government help maintain this illusion, enticing them to vote for advocates of smaller government. By contrast, voters in highly urban areas may assume they are the ones who get the most subsidies. In turn, they vote for big-government politicians, thinking that welfare spending will ease social frictions in big cities. Ultimately, everyone is wrong.</p>
<p>Another explanation holds that voters are simply irrational. In the words of the George Mason economist Bryan Caplan, &ldquo;Voters often see themselves as they want to be, not as they really are. People in red states tend to think that &lsquo;government is the problem,&rsquo; so they tell themselves that big government is mostly a problem in blue states. People in blue states tend to think that &lsquo;government is the solution,&rsquo; so they tell themselves that their government takes care of people.&rdquo;</p>
<p>These hypotheses may explain some voters&rsquo; behavior, but they amount to generalized guesses about other people&rsquo;s thought processes. Two other theories take a closer look at the data.</p>
<p>In &ldquo;Rich State, Poor State, Red State, Blue State,&rdquo; a 2007 paper for the <em>Quarterly Journal of Political Science</em>, four researchers&mdash;Andrew Gelman of Columbia, Boris Shor of the University of Chicago, Joseph Bafumi of Dartmouth, and David Park of George Washington University&mdash;explain that while richer voters are more likely to be Republican than poorer voters, this tendency is weaker in blue states. Take two equally wealthy people. One lives in a blue state and the other lives in a red state. The data show that the voter living in the richer blue state is more likely to be a Democrat than the one in the poorer red state, although both are more likely to be Republican than a poor resident of either state. Simply put: Income plays a greater role in determining voter preference in red states than in blue ones. So while voters in red states are more motivated by their financial interests (or perceived financial interests), issues outside of income are more powerful motivators for blue voters. This pattern could help explain why some states vote Democratic despite their wealth and some states vote Republican despite their poverty.</p>
<p>The second theory, which is consistent with the first, holds that Republican voters want to reduce federal spending only if it means cutting <em>other</em> people&rsquo;s handouts. That would explain why elected Republicans in red states, such as Sen. Charles Grassley (R-Iowa), don&rsquo;t let their limited-government rhetoric get in the way of voting for farm subsidies.</p>
<p>In the end, the red/blue paradox may be a product of our tendency to look for ideological consistency in politics when there isn&rsquo;t any. The Republican and Democratic parties, like all political coalitions, are umbrella groups that include very different interests. Pro-lifers share a party with hawks, gun controllers with immigration reformers. The role of ideology may be to make contradictory impulses seem coherent and connected. &nbsp;</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> (vderugy&#64;gmu.edu), a senior research fellow at the Mercatus Center at George Mason University, writes a monthly economics column for</em> <strong>reason. </strong><em>This column <a href="http://reason.com/archives/2011/07/14/the-redblue-paradox">first appeared</a> at Reason.com.</em></p>1011915@http://www.reason.orgThu, 14 Jul 2011 10:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts About Stimulus Spendinghttp://www.reason.org/news/show/the-facts-about-stimulus-spending
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<p><em>Editor&rsquo;s</em> <em>Note: Reason <a href="/people/veronique-de-rugy/all">columnist</a> and <a href="http://mercatus.org/">Mercatus Center</a> economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Stimulus spending can jump start the economy and fix unemployment.</em></p>
<p><strong>Fact 1:</strong> <em>Recent experience suggests stimulus spending won&rsquo;t help.</em></p>
<p>There&rsquo;s no question President Barack Obama inherited a lousy economy. Yet even many prominent Democrats, including Senate Majority Whip Dick Durbin and Democratic National Committee chair Debbie Wasserman Schultz, now acknowledge that after two and a half years in office, <a href="http://abcnews.go.com/Politics/obama-tells-republicans-deficit-reduction-tax-hikes/story?id=13956637&amp;page=2"> the president owns the economy</a>. Unfortunately for him, things still aren&rsquo;t looking so so good. That&rsquo;s why the president called on Congress last week to pass a series of spending measures that he said would boost the economy, including additional infrastructure spending and an extension of the payroll tax cut for another year.</p>
<p>With this in mind, I thought it would be interesting to update my chart on the level of stimulus spending and unemployment <a href="http://www.nationalreview.com/corner/271207/new-stimulus-veronique-de-rugy"> rates</a> since 2009.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/Stim1.jpg" border="0" width="471" height="341" /></p>
<p>The chart is based on the most recent data from the Bureau of Labor Statistics and the Center for Data Analysis. As you can see, the administration&rsquo;s promise that the American Recovery and Reinvestment Act (ARRA) would keep unemployment rates from reaching 8.8 percent and would create some 3 million jobs&mdash;90 percent of them in the private sector&mdash;did not materialize.</p>
<p>The unemployment rate started at 7.6 percent when President Obama took office and peaked at 10.2 percent in October 2009. Since the enactment of the stimulus bill in February 2009, the unemployment rate has not approached pre-ARRA levels, even though $382 billion has been made available by government departments and agencies (on top of tax credits and other tax-related items). In fact, unemployment recently edged up, from 9 percent in April to 9.1 percent in May.</p>
<p>Based on this data, it is hard to make the case that doing more of the same will help. Yet that is precisely what <em>New York Times</em> columnist Paul Krugman think we should do. In his view, these dire results are due to a stimulus <a href="http://krugman.blogs.nytimes.com/2011/07/03/bad-tayloring/">that was too small</a>. It&rsquo;s difficult to imagine what level of stimulus spending would be large enough for Krugman. What I do know is that we have spent $666 billion to date, yet unemployment&nbsp;remains above 9 percent. And under even the <a href="http://www.whitehouse.gov/sites/default/files/cea_7th_arra_report.pdf"> rosiest of assumptions</a>, which claim 2.4 million jobs created, each of those jobs cost $278,000 (see <a href="http://www.whitehouse.gov/sites/default/files/cea_7th_arra_report.pdf"> here</a>).</p>
<p><strong>Myth 2:</strong> <em>Additional infrastructure spending is an effective way to stimulate the economy and create jobs.</em></p>
<p><strong>Fact 2:</strong> <em>In theory, infrastructure spending injects more money into the economy than other types of government spending. In reality, however, politicians rarely include infrastructure spending in stimulus bills. Instead, they spend money on items like transfers and tax cuts. Only 3 percent of the last stimulus went to infrastructure.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/Stim-2.jpg" border="0" width="431" height="306" /></p>
<p>Economists on both sides of the aisles argue that one reason why the stimulus failed is that it wasn&rsquo;t designed properly. Stanford University&rsquo;s John Taylor, for instance, has argued that although much money was spent, very little stimulus money was spent in the form of actual government purchase. In a paper with he <a href="http://www.stanford.edu/%7Ejohntayl/Cogan%20Taylor%20multiplicand%2010-25.pdf"> co-authored with John Cogan</a>, Taylor finds that, out of the total $682 billion package, federal infrastructure spending was just $0.9 billion in 2009 and $1.5 billion through the first half of 2010&mdash;or less than four-tenths of 1 percent.</p>
<p>Taylor and Cogan also noted that most of the money generated by tax cuts was saved, not spent, and that the money that went to state governments was spent to reduce the states&rsquo; reliance on borrowing and on other &ldquo;non-purchase&rdquo; items, such as transfer payments, subsidies, and interest payments. In other words, the additional money that went to states and taxpayers didn&rsquo;t change a thing. Taylor claims that a better-designed stimulus would have probably been more effective.</p>
<p>But experience tells us that the next stimulus won&rsquo;t be any better. As the chart above shows, only 3 percent of the last stimulus went to infrastructure spending. Why? Because such programs are not political winners. For one thing, they take too long to produce results. Therefore they always take a back seat to politically-popular tax credits and transfers to the states.</p>
<p>Furthermore, while it may be true that additional infrastructure spending would have proved more effective than the current stimulus, that doesn&rsquo;t change the fact that once the stimulus money goes away, the jobs and increased demand also disappear, and the government is left holding the debt.</p>
<p><strong>Myth 3:</strong> <em>Tax rebates will stimulate the economy.</em></p>
<p><strong>Fact 3:</strong> <em>The evidence says they don&rsquo;t. First, people usually save the extra money. Second, even if tax rebates did increase consumption, companies don&rsquo;t hire employees or build new plants because of a one-time boost.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/stim3.png" border="0" width="432" height="342" /></p>
<p>This chart shows how personal disposable income jumped thanks to the 2008 tax rebate, the tax credits in the stimulus, and the 2010 payroll tax cut. It also shows that personal consumption did not increase noticeably as a result of these government actions. In fact, formal statistical work by Joel Slemrod, a professor of tax policy at the University of Michigan, has shown that rebates generally produce no statistically significant increase in consumption. Basically, tax credits and rebates produce greater savings, not greater consumption.</p>
<p>The theory that tax rebates and payroll tax cuts will result in an increase in consumption suffers from several serious problems. First, it assumes people don&rsquo;t realize that the extra cash flow is temporary and that businesses don&rsquo;t realize that the new consumption won&rsquo;t last. Tax rebates, for example, assume that if people get extra money to increase their consumption, businesses will then expand production and hire more workers. But this is not true. Even if producers notice an upward blip in sales after the rebate checks go out, they will know it's temporary. Companies won't hire more employees or build new factories in response to a temporary increase in sales. Those who are foolish enough to do so will go out of business.</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> is a senior research fellow at the <a href="http://mercatus.org/">Mercatus Center</a> at George Mason University.</em></p>1011897@http://www.reason.orgFri, 08 Jul 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts about American Prisonshttp://www.reason.org/news/show/the-facts-about-american-prisons
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<p><em>Editor&rsquo;s</em> <em>Note: Reason&nbsp;<a href="/archives/2011/archives/2011/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Incarceration rates in the U.S. are comparable to the rates in other industrial countries.</em></p>
<p><strong>Fact 1:</strong> <em>U.S. incarceration rates are significantly larger than those in any other liberal democracy.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/prisons1.jpg" border="0" width="598" height="407" /></p>
<p>In 2009, according to the Bureau of Justice Statistics, there were 1,524,513 prisoners in state and federal prisons in the United States. When local jails are included, the total climbs to 2,284,913. These numbers are not just staggering; they are far above those of any other liberal democracy in both absolute and per capita terms. The International Centre for Prison Studies at King&rsquo;s College, London calculates that the United States has an incarceration rate of 743 per 100,000 people, compared to 325 in Israel, 217 in Poland, 154 in England and Wales, 96 in France, 71 in Denmark, and 32 in India.</p>
<p>America&rsquo;s enormously high incarceration rate is a relatively recent phenomenon. According to a 2010 report from the Center for Economic and Policy Research (CEPR), U.S. incarceration rates between 1880 and 1970 ranged from about 100 to 200 prisoners per 100,000 people. After 1980, however, the inmate population began to grow much more rapidly than the overall population, climbing from about 220 per 100,000 in 1980 to 458 in 1990, 683 in 2000, and 753 in 2008.</p>
<p><strong>Myth 2:</strong> <em>The rise in the incarceration rate reflects a commensurate rise in crime.</em></p>
<p><strong>Fact 2:</strong> <em>Crime rates have collapsed.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/prisons2.jpg" border="0" width="613" height="459" /></p>
<p>Why are American incarceration rates so high by international standards, and why have they increased so much during the last three decades? The simplest explanation would be that the rise in the incarceration rate reflects a commensurate rise in crime. But according to data from the Federal Bureau of Investigation and the Bureau of Justice Statistics (BJS), the total number of violent crimes was only about 3 percent higher in 2008 than it was in 1980, while the violent crime rate was much lower: 19 per 1,000 people in 2008 vs. 49.4 in 1980. Meanwhile, the BJS data shows that the total number of property crimes dropped to 134.7 per 1,000 people in 2008 from 496.1 in 1980. The growth in the prison population mainly reflects changes in the correctional policies that determine who goes to prison and for how long.</p>
<p>Mandatory minimum sentencing laws enacted in the 1980s played an important role. According to the CEPR study, nonviolent offenders make up more than 60 percent of the prison and jail population. Nonviolent drug offenders now account for about one-fourth of all inmates, up from less than 10 percent in 1980. Much of this increase can be traced back to the &ldquo;three strikes&rdquo; bills adopted by many states in the 1990s. The laws require state courts to hand down mandatory and extended periods of incarceration to people who have been convicted of felonies on three or more separate occasions. The felonies can include relatively minor crimes such as shoplifting.</p>
<p><strong>Myth 3:</strong> <em>The drop in violent crimes is the result of &ldquo;tough on crime&rdquo; policies, particularly expanded prison sentences.</em></p>
<p><strong>Fact 3:</strong> <em>Only a small share of the drop in violent crime is the result of expanded incarceration.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/prisons3.jpg" border="0" width="579" height="393" /></p>
<p>For many, America&rsquo;s soaring incarceration rate and the drop in crime that began 20 years ago are connected. The theory is that if you punish people and make it very costly to commit a crime (expand incarceration), they will have an incentive to live a more virtuous life.</p>
<p>A good question then is whether or not tough sentences have accomplished this? Research by the Pew Center on the States suggests that expanded incarceration accounts for about 25 percent of the drop in violent crime that began in the mid-1990s&mdash;leaving the other 75 percent to be explained by things that have nothing to do with keeping people locked up.</p>
<p>If it wasn&rsquo;t incarceration, what caused the drop?</p>
<p>As <em>Reason</em> contributing editor Radley Balko <a href="http://reason.com/archives/2011/06/20/the-crime-rate-puzzle">explains</a>, &ldquo;There is no shortage of theories: Scholars have pointed to everything from the legalization of abortion to the prohibition of lead-based paints. Other theories credit America&rsquo;s aging population (the vast majority of criminals are under 30), President Bill Clinton&rsquo;s program to put more cops on the street, and either stronger gun control laws or an increase in gun carrying by law-abiding Americans.&rdquo;</p>
<p>He concludes:</p>
<blockquote>
<p>More likely, crime scholars argue, we probably have less crime now not because of any anti-crime initiatives dreamed up by academics and politicians but because civil society has quietly churned out benefits independent of those policies. Basically, we are wealthier and the opportunity cost of being incarcerated is high at all level of income.</p>
</blockquote>
<p>On that point, it is also worth reading this <a href="http://reason.com/archives/2005/11/01/prince-rudys-courtier">great piece</a> by <em>Reason</em> Senior Editor Tim Cavanaugh about the drop in New York City&rsquo;s crime rate.</p>
<p><em>Contributing Editor&nbsp;Veronique de Rugy&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University.</em></p>1011842@http://www.reason.orgFri, 24 Jun 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts about Transportation Spendinghttp://www.reason.org/news/show/the-facts-about-transportation-spen
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<p><em>Editor's Note: Reason&nbsp;<a href="/archives/2011/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p>The United States spends about <a href="http://cboblog.cbo.gov/?p=2188">$160 billion annually</a> on highways, with about one-fourth of that total coming from the federal government. Federal highway spending is funded mainly through gas and other fuel taxes that are paid into the <a href="http://www.fhwa.dot.gov/reports/financingfederalaid/fund.htm">Highway Trust Fund</a>. In recent years, however, the amount of money Congress has spent out of the general fund has exceeded the dedicated trust funds set aside for highway spending.</p>
<p><strong>Myth 1:</strong> <em>Highways and roads pay for themselves thanks to gasoline taxes and other charges to motorists.</em></p>
<p><strong>Fact 1:</strong> <em>They don&rsquo;t. Gas taxes and other highway user fees pay less today than ever before.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/transit1.jpg" border="0" width="602" height="446" /></p>
<p>In 1957 about 67 percent of highway funds came from user fees. Forty years later the revenue from user fees has shrunk to just 50 percent of total highway funds. Indeed, user fee revenue as a share of total highway-related funds is now at its lowest point since the Interstate Highway System was created.</p>
<p>And the difference is now made up by taxes and fees not directly related to highway use. These include revenue generated by sales and property taxes, general fund appropriations, investment income, and various bond issues.</p>
<p>This growing proportion of non-user revenue reveals a profound shift in the nature of highway funding, and has consequently led to <a href="http://subsidyscope.org/transportation/highways/funding/">increasing debate</a> about the future of America&rsquo;s highways. This <a href="http://www.cbo.gov/ftpdocs/121xx/doc12173/05-17-HighwayFunding.pdf"> discussion</a> has also been fueled by the approaching expiration date this September for an important Highway Trust Fund law.</p>
<p>Which means that now is the time to think outside of the box and to consider privatizing America&rsquo;s highways.</p>
<p><strong>Myth 2:</strong> <em>Proceeds from the federal gas tax are used to build and maintain the interstate highway system.</em></p>
<p><strong>Fact 2:</strong> <em>That was the promise made to taxpayers in 1956. Today, however, at least 25 percent of federal gas tax funds are diverted to non-highway uses including maintaining sidewalks, funding bike paths, and creating scenic trails.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/transit2.jpg" border="0" width="579" height="430" /></p>
<p>Fuel tax revenues are now insufficient to maintain the current level of highway spending. As the Congressional Budget Office <a href="http://www.cbo.gov/ftpdocs/120xx/doc12043/01-19-HighwaySpending_Brief.pdf"> noted</a> in its discussion of the weaknesses of the fuel tax system: It does not account for the costs of congestion, it is a fixed cost per gallon (meaning it does not adjust with inflation), and it provides insufficient revenues to pay for the costs that users impose on the system. Moreover, it is clear that the diversion of gas tax funds to non-highway projects is the biggest cause of the underfunding problem.</p>
<p>As Reason Foundation Director of&nbsp; Transportation Policy Robert Poole <a href="http://reason.com/archives/2010/03/05/road-to-ruin">has explained</a>:</p>
<blockquote>
<p>The federal HTF was invented in 1956, promising motorists and truckers that all proceeds from a new federal gas tax would be spent on building the interstate system. They aren't. Congress has expanded federal highway spending beyond interstates to include all types of roadways. And since 1982, a portion of "highway user taxes" have been diverted to urban transit (non highway use). Today, the federal role in transportation includes maintaining sidewalks, funding bike paths, and creating scenic trails.</p>
</blockquote>
<p>Poole estimates that some 25 percent of the gas tax goes to non-highway use. As the Federal Highway Administration&rsquo;s <a href="http://www.fhwa.dot.gov/safetealu/safetea-lu_authorizations.xls">&ldquo;Highway Authorizations&rdquo;</a> table indicates, Congress allocates highway money to truck parking facilities, safety incentives to prevent operation of motor vehicles by intoxicated persons, grants for anti-racial profiling programs, magnetic levitation trains, and dozens of other non-road activities. The main diversion is to rail and public transit, which leads us to the next myth.</p>
<p><strong>Myth 3:</strong> <em>Increased spending on public transit will boost ridership. Therefore we need to transfer highway dollars to transit programs and increase state and local taxes to fund transit agencies.</em></p>
<p><strong>Fact 3:</strong> <em>There is no visible relation between transit funding and transit ridership. Despite huge increases in public transit funding over the past two decades, ridership has barely increased.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/transit3.jpg" border="0" width="603" height="437" /></p>
<p>Despite huge increases in transit funding over the past two decades, ridership has remained constant. Using American Public Transportation Administration (APTA) <a href="http://www.apta.com/resources/statistics/Documents/FactBook/2010_Fact_Book_Appendix_A.pdf"> data</a>, the chart above reveals that ridership has barely changed as funding has drastically increased&mdash;especially if you control for the increasing number of transit systems, and the level of population growth over time.</p>
<p>Although transit funding in 1995 was eight times more than it was in 1978 (17.4 billion and 2.2 billion respectively), the total increase in ridership was only about 2 percent. Total ridership in 1978 (7.8 billion trips) was actually more than ridership in 1995 (7.7 billion trips)&mdash;the only difference was in the amount of funding. Between 1989 and 1996 ridership fell by 11 percent; again, this was while funding increased by 42 percent.</p>
<p>These funding increases have included federal, state, and local taxpayer assistance to transit. Moreover, about a quarter of these subsidies come directly from highway user fees. Cato Institute Senior Fellow Randal O&rsquo;Toole <a href="http://reason.org/files/8b9a112cf745cb6ba869504382cbea92.pdf">claims</a> that &ldquo;because transit produces less than 5 percent of urban transport, while autos produce more than 90 percent, it is safe to say that most of the taxes supporting transit are subsidies from auto users to transit riders.&rdquo;</p>
<p>The reasons for the shortcomings in transit ridership have less to do with the amount of available funds than with the fact that rail lines are expensive to build, maintain, and operate, and the fact that most transit systems have at some point been forced to significantly raise fares and/or curtail services, often leading to the loss of transit riders.</p>
<p>According <a href="http://www.cato.org/pub_display.php?pub_id=8746">to O&rsquo;Toole</a>, &ldquo;Thanks in part to the high cost of rails, transit systems in Atlanta, Baltimore, Buffalo, Chicago, Cleveland, Philadelphia, Pittsburgh, St. Louis, and the San Francisco Bay Area carried fewer riders in 2005 than two decades before. Los Angeles lost 17 percent of its bus riders when it began building rail transit.&rdquo; The fact that transit workers are generally members of public sector unions hasn&rsquo;t helped either.</p>
<p>None of this means that transit agencies will never be able to attract new riders. But it does mean that simply throwing more money at transit isn&rsquo;t the answer.</p>
<p><em>Contributing Editor&nbsp;Veronique de Rugy&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University.</em></p>1011821@http://www.reason.orgFri, 17 Jun 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts about the Alternative Minimum Taxhttp://www.reason.org/news/show/the-facts-about-the-alternative-min
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<p><em>Editor's Note: Reason&nbsp;<a href="/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>The Alternative Minimum Tax targets millionaires.</em></p>
<p><strong>Fact 1:</strong> <em>While the Alternative Minimum Tax was originally created to target millionaires, today it falls most heavily on non-millionaires.</em></p>
<p>The Alternative Minimum Tax (AMT) was created in 1969 to prevent 155 wealthy taxpayers from using deductions and credits to avoid paying any federal income taxes.</p>
<p>Here&rsquo;s how it works. Taxpayers who are subject to the AMT must calculate their tax liability twice, once under regular income tax rules and again under AMT rules. If liability under the AMT proves higher, taxpayers pay the difference as an add-on to the regular tax. The difference paid is their AMT.</p>
<p>However, mainly due to the <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1753192">failure to index the AMT</a> for inflation in 1981 when the regular income tax was indexed, the reach of the AMT has expanded over time to hit middle-income people it was never intended to tax. As a result, the AMT impacts a growing share of the population. According to the <a href="http://www.cbo.gov/ftpdocs/108xx/doc10800/01-15-AMT_Brief.pdf">Congressional Budget Office</a>, last tax season 4.5 million taxpayers were affected by the alternative minimum tax, an increase of over 4 million taxpayers since 1970. &nbsp;</p>
<p>Until 2000, less than 1 percent of taxpayers paid the AMT in any given year; by 2008, 3 percent of taxpayers were subject to the AMT. And its costs go far beyond increased tax liabilities.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/AMT1.jpg" border="0" width="459" height="330" /></p>
<p>This chart shows the composition of taxpayers affected by the Alternative Minimum Tax in 2009 by adjusted gross income (AGI), using data from the 2010 CBO Brief, &ldquo;The Individual Alternative Minimum Tax.&rdquo;</p>
<p>As you can see, the AMT hits far more than the highest-income individuals. In fact, only 10 percent of AMT revenue came from taxpayers making above $500,000 and only a fraction of those people are millionaires.</p>
<p>Also, the majority of AMT revenue came from taxpayers in the $200,000-$500,000 (in 2009 dollars) income range while some 5 percent of revenue came from taxpayers making less than $100,000.</p>
<p>As we see, 23 percent of AMT revenue came from taxpayers with income between $100,000 and $200,000.</p>
<p>This evidence stands in sharp contradiction with the original purpose of the AMT, which was to prevent 155 millionaires from using deductions and credits to avoid paying any federal income tax.&nbsp;</p>
<p><strong>Myth 2:</strong> <em>The AMT is family friendly.</em></p>
<p><strong>Fact 2:</strong> <em>Households with three or more children are four times more likely to pay the AMT than households with zero children.</em></p>
<p>The AMT disallows certain tax breaks, especially state and local tax deductions and the personal exemption. As a result, the AMT hits some taxpayers harder than others. Married couples with children and taxpayers in high-tax states are disproportionately hit by the AMT.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/AMT2.jpg" border="0" width="529" height="375" /></p>
<p>This chart compares AMT liability among taxpayers based on the number of children in their households in 2010, using data from the Tax Policy Center&rsquo;s &ldquo;Characteristics of AMT Taxpayers.&rdquo; The number of children is defined as the number of exemptions taken for children living at home. As the numbers show, an increase in the number of children in a household was accompanied by an increase in the AMT liability. Thus 8.6 percent of households with three or more children had liability under the AMT. Essentially, if you have three or more children you pay over four times the amount of people who have no children.</p>
<p><strong>Myth 3:</strong> <em>The Republicans are the only party strongly opposed to the AMT.</em></p>
<p><strong>Fact 3:</strong> <em>While Republicans would be happy to repeal the AMT, Democrats are also opposed to it. That&rsquo;s because almost 50 percent of AMT revenue comes from four Democratic strongholds: California, Massachusetts, New Jersey, and New York.</em></p>
<p>The AMT hits some taxpayers harder than others, especially those who would otherwise claim large deductions for their state and local taxes.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/AMT3.jpg" border="0" width="555" height="305" /></p>
<p>This chart illustrates the proportion of AMT payers in various states using data from the Tax Policy Center (&ldquo;Alternative Minimum Tax by State, Tax Year 2008&rdquo;). Nearly 48 percent of the total revenue from the AMT is collected from just four states--California, Massachusetts, New Jersey, and New York--amounting to one-twelfth of all states. The remaining 52 percent is shared by the rest of the country.</p>
<p>Nearly half of all states pay less than 0.7 percent of total AMT revenues each, but in California taxpayers who paid the AMT made up 22 percent of total AMT revenues, while 15.5 percent of AMT revenues came from New York, 7 percent from New Jersey, and 3.5 percent from Massachusetts. The bottom line is that the AMT hits people in some states harder than others.</p>
<p>This is why Democrats such as Rep. Charles Rangel (D-N.Y.), are so upset about the AMT. The tax hits liberal states the hardest.</p>
<p>In addition, taxpayers also have to deal with what&rsquo;s called the &ldquo;real bracket phenomenon.&rdquo; Bracket creep occurs when people experience an increase in wages, salary, or other income that moves them from one tax bracket to the next highest bracket. For instance, because the AMT isn&rsquo;t indexed for inflation, growth in nominal income tends to raise the AMT liability more than regular income tax liability. This phenomenon is especially pernicious in places with a high cost of living like New York City, where some employers offer generous salaries to offset sky-high rents and other city-related costs. Since the inflation index used to set the brackets does not appropriately take these localized costs into account, the more people earn to make up for the high cost of living, the more likely they are to be hit by the AMT.</p>
<p><em>Contributing Editor&nbsp;Veronique de Rugy&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University.</em></p>
<p><em>Editor's Note:</em> This article originally misstated the percentage of AMT revenue coming from taxpayers making between $100,000-$200,000 annually.</p>1011800@http://www.reason.orgFri, 10 Jun 2011 13:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)Prison Mathhttp://www.reason.org/news/show/prison-math
<p>In 2009, according to the Bureau of Justice Statistics, there were 1,524,513 prisoners in state and federal prisons. When local jails are included, the total climbs to 2,284,913. These numbers are not just staggering; they are far above those of any other liberal democracy in both absolute and per capita terms. The International Centre for Prison Studies at King&rsquo;s College London calculates that the United States has an incarceration rate of 743 per 100,000 people, compared to 325 in Israel, 217 in Poland, 154 in England and Wales, 96 in France, 71 in Denmark, and 32 in India.</p>
<p>America&rsquo;s enormously high incarceration rate is a relatively recent phenomenon. According to a 2010 report from the Center for Economic and Policy Research (CEPR), U.S. incarceration rates between 1880 and 1970 ranged from about 100 to 200 prisoners per 100,000 people. After 1980, however, the inmate population began to grow much more rapidly than the overall population, climbing from about 220 per 100,000 in 1980 to 458 in 1990, 683 in 2000, and 753 in 2008.</p>
<p>Why are American incarceration rates so high by international standards, and why have they increased so much during the last three decades? The simplest explanation would be that the rise in the incarceration rate reflects a commensurate rise in crime. But according to data from the Federal Bureau of Investigation and the Bureau of Justice Statistics (BJS), the total number of violent crimes was only about 3 percent higher in 2008 than it was in 1980, while the violent crime rate was much lower: 19 per 1,000 people in 2008 vs. 49.4 in 1980. Meanwhile, the BJS data shows that the total number of property crimes dropped to 134.7 per 1,000 people in 2008 from 496.1 in 1980. The growth in the prison population mainly reflects changes in the correctional policies that determine who goes to prison and for how long.&nbsp;</p>
<p>Mandatory minimum sentencing laws enacted in the 1980s played an important role. According to the CEPR study, nonviolent offenders make up more than 60 percent of the prison and jail population. Nonviolent drug offenders now account for about one-fourth of all inmates, up from less than 10 percent in 1980. Much of this increase can be traced back to the &ldquo;three strikes&rdquo; bills adopted by many states in the 1990s. The laws require state courts to hand down mandatory and extended periods of incarceration to people who have been convicted of felonies on three or more separate occasions. The felonies can include relatively minor crimes such as shoplifting.&nbsp;</p>
<p>What have longer prison sentences accomplished? Research by the Pew Center on the States suggests that expanded incarceration accounts for about 25 percent of the drop in violent crime that began in the mid-1990s&mdash;leaving the other 75 percent to be explained by things that have nothing to do with keeping people locked up.</p>
<p>As for the costs, state correctional spending has quadrupled in nominal terms in the last two decades and now totals $52 billion a year, consuming one out of 14 general fund dollars. Spending on corrections is the second fastest growth area of state budgets, following Medicaid. According to a 2009 report from the Pew Center on the States, keeping an inmate locked up costs an average of $78.95 per day, more than 20 times the cost of a day on probation.</p>
<p>More important is the long-term impact that the tough-on-crime policies of the last two decades have had on prisoners and society. Housing nonviolent, victimless offenders with violent criminals for years on end can&rsquo;t possibly help them reintegrate into society, which helps explain why four out of 10 released prisoners end up back in jail within three years of their release.</p>
<p>As the Harvard sociologist Bruce Western and the University of Washington sociologist Becky Pettit showed in a 2010 study published by the Pew Center on the States, incarceration has a lasting impact on men&rsquo;s earnings. Taking age, education, school enrollment, and geography into account, they found that past incarceration reduced subsequent wages by 11 percent, cut annual employment by nine weeks, and reduced yearly earnings by 40 percent. Only 2 percent of previously incarcerated men who started in the bottom fifth of the earnings distribution made it to the top fifth 20 years later, compared to 15 percent of never-incarcerated men who started at the bottom.&nbsp;</p>
<p>It isn&rsquo;t just offenders whose lives are damaged. Western and Pettit note that 54 percent of inmates are parents with minor children, including more than 120,000 mothers and 1.1 million fathers. One in every 28 children has a parent incarcerated, up from 1 in 125 just 25 years ago. Two-thirds of these children&rsquo;s parents were incarcerated for nonviolent offenses.</p>
<p>While we don&rsquo;t yet have data on the income mobility of these children, Rucker C. Johnson of the Goldman School of Public Policy found in 2009 that children whose fathers have been incarcerated are significantly more likely than their peers to be expelled or suspended from school (23 percent compared to 4 percent). Johnson found that family income, averaged over the years a father is incarcerated, is 22 percent lower than family income the year before his incarceration. Even in the year after the father is released, family income remains 15 percent lower than it was the year before incarceration. Both education and parental income are strong indicators of a child&rsquo;s future economic mobility.&nbsp;</p>
<p>Attempts to estimate the costs and benefits of prison have proved difficult and controversial. In 1987, for example, the National Institute of Justice economist Edwin Zedlewski used national crime data to calculate that the typical offender commits 187 crimes a year and that the typical crime exacts $2,300 in property losses or in physical injuries and human suffering. Multiplying these two figures, Zedlewski estimated that the typical imprisoned felon is responsible for $430,000 in &ldquo;social costs&rdquo; each year he is free. Dividing that figure by an annual incarceration cost of $25,000, he concluded that the public benefits of imprisonment outweigh the costs by 17 to 1.</p>
<p>Zedlewski&rsquo;s findings have been debunked many times. A severe rebuttal came from the Boalt Hall Law School penologists Franklin Zimring and Gordon Hawkins, who argued in a 1988 article published by the National Council of Crime and Delinquency that Zedlewski overstated the net benefit of incarceration by inflating the numerator (crimes per offender and social costs per crime) and deflating the denominator (annual cost of confinement). They cited several studies to bolster their charge, including one indicating that the typical offender commits 15 (as opposed to 187) crimes in a year. According to a 1991 Brookings paper by John J. DiIulio and Anne Morrison Piehl, making this one adjustment to the calculations reduces the benefit/cost ratio to 1.38. In other words, the benefit of incarceration is probably small, especially compared to the high cost of locking people up. Also note that Zedlewski assumed imprisoned offenders were predatory criminals, although a substantial share of real-world convicts are guilty only of victimless crimes.</p>
<p>Fortunately, economists are getting better at understanding how to keep people out of jail. In a 2007 paper for <em>Economic Inquiry</em>, for instance, the U.C.&ndash;Santa Barbara economist Jeff Grogger found there are large deterrent effects from increased certainty of punishment and much smaller, generally insignificant effects from increased severity. Such findings call into question the economic rationality of increasingly long prison terms. Who knows how many more millions will be locked up by the time public policy finally catches up with economics?&nbsp;</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> (vderugy&#64;gmu.edu) is a senior research fellow at the Mercatus Center at George Mason University. She writes a monthly economics column for</em> <strong>reason. </strong><em>This column <a href="http://reason.com/archives/2011/06/08/prison-math">first appeared</a> at Reason.com.</em></p>1011762@http://www.reason.orgWed, 08 Jun 2011 13:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts about the Governmentâ??s Medicare Cost Projectionshttp://www.reason.org/news/show/the-facts-about-the-governments-med
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<p><em>Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth:</strong> <em>The government&rsquo;s cost projections are reliable.</em></p>
<p><strong>Fact:</strong> <em>They are not. No matter what governmental body does the scoring, it is almost invariably unreliable.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/projections1.jpg" border="0" width="462" height="316" /></p>
<p>In 1967 long-run forecasts estimated that Medicare would cost about $12 billion by 1990. In reality, it cost more than $98 billion that year. Today it costs $500 billion.</p>
<p>When it comes to the federal government, massive cost overruns <a href="http://reason.com/archives/2010/02/16/congress-phony-price-tags">are the rule</a>, not the exception. The <a href="http://www.fas.org/sgp/crs/natsec/RL33110.pdf">$800 billion cost of the war in Iraq</a> dwarfs the $50-60 billion that Mitch Daniels, then director of the Office of Management and Budget, predicted at the outset. In light of these numbers it&rsquo;s interesting to remember that Larry Lindsey, President George W. Bush&rsquo;s economic advisor, was fired for <a href="http://money.cnn.com/2008/01/10/news/economy/costofwar.fortune/index.htm"> projecting that the war</a> could cost between 1 and 2 percent of GDP back in 2002 (roughly between $100 and $200 billion).</p>
<p>Strangely, lawmakers seem to never expect these extra costs even when the excesses take place under their own noses. The Capitol Hill Visitor Center, an ambitious three-floor underground facility, originally scheduled to open at the end of 2005, was delayed until 2008. The price tag exploded from an original estimate of $265 million in 2000 to a final cost of $621 million.</p>
<p>At the heart of the problem is the massive amount of <a href="http://mercatus.org/sites/default/files/publication/Budget%20Gimmicks%20Research%20Summary%20de%20Rugy%20%282%29.pdf"> budget gimmicks</a>, the abuse of rosy scenarios, the emergency spending loopholes, and a lack of fiscal discipline by lawmakers who just can&rsquo;t stop spending the taxpayers&rsquo; money.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/projections2.jpg" border="0" width="447" height="306" /></p>
<p>This chart compares Congressional Budget Office long-term projections of the debt held by the public from 2010 with long-term projections calculated in 2007. In 2007, the CBO projected that the debt held by the public would surpass 60 percent in 2023. Note that this long-term projection incorporated policy changes that were deemed likely at the time. Using the same methodology last year, the CBO projected that the debt will exceed 60 percent of GDP by the end of 2010. In the three years between projections, the debt milestone has accelerated by 13 years. This unforeseen acceleration is worth careful consideration; as the government consumes more credit, less will be available to the private sector.</p>
<p>In other words, even even short-term economic projections are frequently unreliable&mdash;especially when the projections are done by the government.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/projections3.jpg" border="0" width="485" height="309" /></p>
<p><a href="http://mercatus.org/publication/medicare-expenditures-under-cms-alternative-scenario"> The above chart</a> shows what a more realistic path for Medicare spending may look like. It compares the long-term projections of Medicare costs under the current law (the 2011 Trustees Report) with the Centers for Medicare and Medicaid Services&rsquo; Office of the Actuary&rsquo;s alternative projections (2011 Trustees Report Alternative). The <a href="https://www.cms.gov/ReportsTrustFunds/Downloads/2011TRAlternativeScenario.pdf"> latter projections</a> were released as a &ldquo;best estimate&rdquo; of future Medicare expenditures to address the &ldquo;likely understatement of current-law projections.&rdquo;</p>
<p>These projections primarily differ in their assumptions about the plausibility of drastic payment-rate cuts. If such cuts do not materialize, Medicare will cost tens of billions more each year than current law projects.</p>
<p>Furthermore, under the Patient Protection and Affordable Care Act, physician payments are tied to a sustainable growth rate mechanism (SGR), which adjusts repayment rates in order to cap physician-related spending. Since 2001, physicians have been scheduled to receive at least a 5 percent reimbursement cut each year under SGR; and this cut has been overridden by Congress every year except 2002.</p>
<p>In 2012, physician payments are scheduled to decrease by 29.4 percent&mdash;an update which is <a href="http://www.nationalreview.com/corner/268312/medicaremediscare-spending-veronique-de-rugy"> extremely unlikely to occur</a>. So while the Board of Trustees is legally bound to incorporate these cost savings into its projections, the Office of the Actuary has formed a more realistic baseline which incorporates increasing physician repayments into the total cost of Medicare.&nbsp;</p>
<p>Under the current-law baseline, Medicare spending is projected to grow from 3.99 percent of GDP in 2020 to 6.25 percent of GDP in 2080; under the alternative scenario, Medicare spending is projected to grow from 4.31 percent of GDP in 2020 to 10.36 percent of GDP in 2080. In nominal terms, this is a cost underestimation of $2.7 trillion dollars by the year 2080.&nbsp;</p>
<p><em>Contributing Editor&nbsp;Veronique de Rugy&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University.</em></p>1011748@http://www.reason.orgFri, 03 Jun 2011 15:00:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts About Taxes and Spendinghttp://www.reason.org/news/show/the-facts-about-taxes-and-spending
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<p><em>Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Millionaires who favor of an income tax increase are fiscal heroes.</em></p>
<p><strong>Fact 1:</strong> <em>No, they&rsquo;re not. Many of the rich get the majority of their income in the form of capital gains and dividends rather than ordinary income. They are essentially advocating a tax increase on those making much less money than they do.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/verotax1.jpg" border="0" width="440" height="314" /></p>
<p>On its face, raising the top income tax rate seems like an effective way to make our (already progressive) federal tax system more progressive. Yet the rationale underlying this policy recommendation ignores the complexities of the United States federal tax system. As you can see from the chart above:</p>
<p>&bull; As income increases, the proportion of Americans&rsquo; earnings coming from wages and salary decreases (red).&nbsp;Meanwhile, wealthy Americans draw much of their income from dividends, interest payments, and capital gains (blue).</p>
<p>&bull; Federal income tax rates are progressive, but they are not shared equally among high earners.&nbsp;Federal income taxes fall disproportionately on those wealthy enough to face the highest income tax rates, yet not wealthy enough to draw a large proportion of their income from non-wage sources -- those filers making $100,000 to $200,000.&nbsp;</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verotax2.jpg" border="0" width="449" height="317" /></p>
<p>So when Facebook&rsquo;s Mark Zuckerberg&mdash;following in the footsteps of billionaires like Bill Gates, Warren Buffett, and Ted Turner&mdash;declared that he was &ldquo;cool&rdquo; with the idea of paying more income tax, it doesn&rsquo;t really mean he&rsquo;s personally going to be paying more money.</p>
<p>Indeed, if Zuckerberg really wants to pay more taxes he can simply send a check to the Treasury Department instead of asking for a tax increase on other people&rsquo;s incomes.</p>
<p>Jakina Debnam of the Mercatus Center calculated the average tax rate on the non-wage and salary earnings of the wealthy using SOI data from the Internal Revenue Service. As she writes: &ldquo;There is some rounding error incorporated from the SOI data. However, if you assume that all high income earners face the highest tax bracket on their income (that they make more than $373,651 in wage and salary income), then you get the tax rates illustrated below.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verotax3.jpg" border="0" width="453" height="228" /></p>
<p>As you can see, these rates are all lower than the individual tax rate on income for single earners making more than $34,500 but less than $83,600, which is 25 percent.</p>
<p><strong>Myth 2:</strong> <em>Big government means more redistribution to the poor.</em></p>
<p><strong>Fact 2:</strong> <em>Large governments tend to have less progressive taxation than smaller ones.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/verotax4.jpg" border="0" width="494" height="348" /></p>
<p>This chart by University of Chicago economist Casey Mulligan shows estimates of the income shares paid by French earners and American earners in various taxes by different income deciles.</p>
<p>Two things are immediately apparent from the chart: 1) French workers pay higher proportions of their income in taxes than their American counterparts at every earnings level and 2) counterintuitively, the American tax system is more progressive than the French system.</p>
<p>According to the Organization for Economic Cooperation and Development, most taxpayers in Western European countries&mdash;countries known for their relatively generous welfare states&mdash;pay a smaller fraction of their income in individual income tax than Americans do.</p>
<p>France&rsquo;s individual income taxes, which are progressive like ours, bring in less than 4 percent of the country&rsquo;s gross domestic product (GDP) to public treasuries, compared with 10 percent for individual income taxes in the United States.</p>
<p>The regressive payroll tax is France&rsquo;s biggest tax, bringing in more than 17 percent of GDP (plus another 4 percent from its flat-rate <em>contribution sociale g&eacute;n&eacute;ralis&eacute;e</em>), compared with the 6 percent of GDP the United States gets from its payroll tax. Customs, excise, and sales taxes amount to 11 percent of GDP in France, but only 4 percent in the United States.</p>
<p><strong>Myth 3:</strong> <em>The doomsday projections about unfunded Social Security and Medicare obligations are overstated.</em></p>
<p><strong>Fact 3:</strong> <em>The unfunded liabilities for Social Security and Medicare exceed one full year of the United States&rsquo; gross domestic product. That&rsquo;s on top of the spending that&rsquo;s supposedly funded.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/verotax5.jpg" border="0" width="463" height="322" /></p>
<p>The net present value of the long term cost of Social Security is $17.9 trillion. The figure for Medicare is $3 trillion. (These are very conservative figures.) Together, that&rsquo;s $20.9 trillion for which we need to cover the difference between the payroll tax and other taxes dedicated to funding the programs and benefits that have been promised. The total size of the U.S. economy is roughly $15 trillion.</p>
<p>The above chart shows the size of the unfunded liabilities for Social Security and Medicare and contrasts that number with the size of the economy today. As you can also see, if we were to put 100 percent of the yearly production of every stock, building, and company in America in a bank account or trust fund, that figure would still not be enough to pay off all of the benefits that have been promised.</p>
<p><em>Contributing Editor&nbsp;Veronique de Rugy&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University. This <a href="http://reason.com/archives/2011/05/27/the-facts-about-taxes-and-spen">first appeared</a> at Reason.com.<br /></em></p>1011729@http://www.reason.orgFri, 27 May 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts About Social Securityhttp://www.reason.org/news/show/the-facts-about-social-security
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<p><em>Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>There is no crisis. Social Security will never be insolvent.</em></p>
<p><strong>Fact 1:</strong> <em>Under the best-case scenario, the trustees report finds that the probability of Social Security never becoming insolvent is less than 2.5 percent.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/veroSS1.jpg" border="0" width="438" height="309" /></p>
<p>The only scenario under which the Social Security trust fund will never go insolvent is based on projections which the Treasury Department itself considers to be extremely unlikely.</p>
<p>The above chart plots the trustees&rsquo; <a href="http://www.ssa.gov/OACT/TR/2010/tr2010.pdf">projections</a> of the future balance of the Social Security trust fund under three scenarios (expressed as a percentage of the annual cost of Social Security).</p>
<p>The purple line plots the trust fund balance under high-cost assumptions, the red line plots the trust fund balance under intermediate assumptions, and the blue line plots the trust fund balance under low-cost assumptions. Which of these projections is most likely to occur?</p>
<p>To determine the likely balance of the trust fund in the future, the Social Security trustees performed <a href="http://www.ssa.gov/OACT/TR/2010/tr2010.pdf">stochastic modeling</a>, estimating the likelihood of various exhaustion dates under different assumptions. This modeling concluded that there is less than a 2.5 percent chance that the trust fund will continue to exist beyond 2048. Instead, the middle of the road estimate is that the trust fund is exhausted by 2036. &nbsp;</p>
<p><strong>Myth 2:</strong> <em>Social Security won&rsquo;t contribute to the federal deficit for decades.</em></p>
<p><strong>Fact 2:</strong> <em>Starting this year the program will run a cash flow deficit which will add to the federal deficit.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/veroSS2.jpg" border="0" width="428" height="316" /></p>
<p>In theory, Social Security benefits are self-financing with a 12.4 percent payroll tax, but that doesn&rsquo;t mean the money collected will pay for benefits. This is because when Congress <a href="http://www.ssa.gov/policy/docs/ssb/v46n7/v46n7p3.pdf">changed the law</a> in 1983 so that in any given year, current taxpayers pay more in taxes than the program needs to pay out benefits, Congress also required that the program&nbsp;invest&nbsp;the difference, or surplus, into a trust fund, which can only invest money in special-issue Treasury bonds.</p>
<p>So what has the Treasury done with the money? Well, the federal government <a href="http://en.wikipedia.org/wiki/Intragovernmental_holdings">has spent it</a> on its daily consumption: education, loan guarantees, wars, etc. In other words, the government has already spent the money it received in exchange for the IOUs. The most recent <a href="http://www.ssa.gov/oact/trsum/index.html">projections</a> say that, beginning in 2014, the program will begin permanently paying out more in benefits than it collects in taxes. At that point, the program will start redeeming the IOUs in the trust fund and use them to pay benefits to current seniors until they run out. But remember, <a href="http://www.ssa.gov/oact/STATS/table4a3.html">the money</a> is not there anymore. So then what? In order to repay the program so it can continue to pay out benefits at the promised levels, the federal government will have to borrow more money, increase taxes to get more revenue, or print more dollars.</p>
<p>The&nbsp;only&nbsp;way Social Security payments to seniors won&rsquo;t increase future deficits is if the federal government prints more money or taxes the American people a second time to pay back the money it owes to the trust fund. My guess is that the government will borrow more money.</p>
<p><strong>Myth 3:</strong> <em>The Patient Protection and Affordable Care Act fixed the funding problems related to Medicare.</em></p>
<p><strong>Fact 3:</strong> <em>Under the best economic assumptions, less than half of all future Medicare spending will come from dedicated sources.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/veroSS3.jpg" border="0" width="433" height="309" /></p>
<p>Medicare is funded by two trust funds,&nbsp;HI (Hospital Insurance) and SMI (Supplementary Medical Insurance).</p>
<p>As we can see on this <a href="http://www.ssa.gov/oact/trsum/images/LD_ChartC.html">chart</a>, even under the best assumptions about the success of the Patient Protection and Affordable Care Act, over 50 percent of all Medicare spending will come from dedicated sources (premiums, tax on benefits, and payroll). By law, SMI spending comes from the general fund. Considering the growth in revenue needed for it, this means that other parts of the budget will have to be reduced or we would have to find other sources of revenue</p>
<p>Also, the HI program is already spending more than it collects while drawing on the assets in its trust fund. Contrary to last year&rsquo;s projections, the trustees report finds that by 2024 (not 2029) the HI trust fund will be exhausted (see the purple above).&nbsp;At this time dedicated HI funds will be sufficient to cover 90 percent of HI costs, meaning that either taxpayers will be forced to make up the difference or the program will be underfunded by 10 percent.</p>
<p>The <a href="https://www.cms.gov/ReportsTrustFunds/03_AboutTheBoard.asp">trustees</a>&mdash;including Secretary of Health and Human Services Kathleen Sebelius and the secretaries of the Treasury and Labor Departments&mdash;say <a href="http://blogs.wsj.com/health/2010/08/05/trustees-say-medicare-fund-will-now-run-out-in-2029-with-caveats/"> &ldquo;nearly all&rdquo;</a> of the improvement in the outlook of the HI trust fund is due to health-care overhaul legislation, which cut some costs, and will raise new revenue via an increased payroll tax and a new tax on investment income.</p>
<p>While Medicare costs over the next 75 years are <a href="http://www.ssa.gov/oact/trsum/index.html">projected</a> to be 25 percent lower due to the health care law, these cost savings rest primarily on drastic reductions in the reimbursement rates for Medicare services&mdash;reductions in reimbursements that are extremely unlikely to happen in a world where politicians are subject to powerful pressures from their constituencies.</p>
<p>Therefore, as the trustees <a href="https://www.cms.gov/ReportsTrustFunds/downloads/2010TRAlternativeScenario.pdf"> note</a>, &ldquo;actual future costs for Medicare are likely to exceed those shown by the current-law projections in this report.&rdquo;</p>
<p><em>Contributing Editor&nbsp;Veronique de Rugy&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University.</em></p>1011688@http://www.reason.orgFri, 20 May 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts About Goldhttp://www.reason.org/news/show/the-facts-about-gold
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<p><em>Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Gold is at an all-time high.</em></p>
<p><strong>Fact 1:</strong> <em>It&rsquo;s not if you adjust for inflation.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/gold1.jpg" border="0" width="416" height="302" /></p>
<p>Media pundits and policy makers claim that gold is at an all-time high. At Carpe Diem, University of Michigan economist Mark Perry <a href="http://mjperry.blogspot.com/2011/04/chart-of-the-day-real-gold-prices.html"> has a useful chart</a> showing that this is only true because such comparisons fail to take into account the effect of inflation on the dollar&rsquo;s value over time. &nbsp;</p>
<p>For example, the average nominal <a href="http://seekingalpha.com/article/70810-the-myth-of-gold-as-an-inflation-hedge"> price</a> of gold was $612.56 in 1980 and $610 in 2006. How much did the dollar&rsquo;s purchasing power decline in those 26 years?</p>
<p>Since the value of a dollar changes over time, comparing the price of any good over time requires that we adjust the current price for inflation. And it turns out that gold is only at record highs if you fail to adjust for inflation. &nbsp;</p>
<p>Perry&rsquo;s chart uses <a href="http://mjperry.blogspot.com/2010/07/chart-of-day-real-gold-prices.html"> data</a> from Global Financial Data to show the changes in the inflation-adjusted price of gold from 1970 (the year before the United States last left the gold standard) to 2010 in real 2010 dollars. Adjusted for inflation, the price of gold today is 41.5 percent below the January 1980 peak of more than $2,000 per ounce (in 2010 dollars). &nbsp;</p>
<p>While not at record highs, the price has certainly been rising. It began doing so a decade ago, around the same time <a href="http://inflationdata.com/inflation/images/charts/Oil/Inflation_Adj_Oil_Prices_Chart.htm"> oil prices began rising</a>. Both fell sharply in the 1980s and 1990s, but they began to increase around 2000, partly because rapid economic growth in Asia was lifting demand for all sorts of commodities.</p>
<p><strong>Myth 2:</strong> <em>Gold is a hedge against inflation.</em></p>
<p><strong>Fact 2:</strong> <em>Gold prices are typically more volatile than the Consumer Price Index.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/gold2.jpg" border="0" width="435" height="308" /></p>
<p>This chart compares the changes in the price levels of gold in red with the consumer price index in blue (recall that the consumer price index, or CPI, is a measure of the changes in prices of all goods and services purchased for consumption by urban households). As you can see, the price level of gold fluctuates drastically while the CPI shifts more modestly. Simply put, this chart illustrates that the price of gold has been more volatile than the overall price level in America throughout recent history.</p>
<p>If gold were indeed a hedge against inflation, we should expect to see a smoothly sloping line illustrating the changes in the price of gold coupled with a more jagged line illustrating the changes in the overall price level&mdash;but this is not the case.</p>
<p>Over the past 10 years, gold&rsquo;s average volatility in a given month was 4.9 percent, according to the World Gold Council; compare this to a roughly 0.15 percent average monthly variation in the Consumer Price Index during the same time period.</p>
<p>So why do investors purchase gold in times of economic recession? Some investors may buy gold to shelter their assets from the risk of inflation. However, it appears that investors overall view gold more as a &ldquo;crisis hedge.&rdquo; According to the Gold World Council&rsquo;s study &ldquo;<a href="http://www.gold.org/investment/research/">Gold Hedging Against Tail Risk</a>,&rdquo; gold is a hedge against infrequent or unlikely risks that could nonetheless dramatically affect one&rsquo;s portfolio, such as government default, systemic risk, and revolution. To many people, gold is a safe commodity in uncertain times.</p>
<p>Another potential factor driving the price increase is that these prices are set in a global marketplace which faces increasing demand and decreasing supply. As emerging markets acquire wealth, they demand more gold jewelry and more investments in gold. The study &ldquo;Gold: A Commodity Like No Other,&rdquo; for example, says that jewelry is responsible for <a href="http://www.gold.org/investment/research/">roughly 50 percent of the market</a> for gold. Gold imports into China have soared this year, making the country a major overseas buyer of gold for the first time in recent history. Indeed, China is on track to overtake India as the world&rsquo;s largest consumer of gold. &nbsp;</p>
<p><img src="http://reason.com/assets/mc/jtaylor/gold3.jpg" border="0" width="418" height="304" /></p>
<p>The chart above uses data from the United States <a href="http://minerals.usgs.gov/ds/2005/140/gold.pdf">geological survey</a> to chart the annual world gold production every year since 1900. As you can see, increasing world demand has been accompanied by a slowing level of world gold production, which could explain some of the increase in the price of gold.</p>
<p><strong>Myth 3:</strong> <em>We are sitting on a gold mine.</em></p>
<p><strong>Fact 3:</strong> <em>While gold is worth more than we think, it is not nearly enough to make a dent in the national debt.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/gold4.jpg" border="0" width="427" height="306" /></p>
<p>At roughly 74 percent, gold makes up the vast majority of the cash, bond, and commodity reserves of the United States. These gold holdings are systematically undervalued since by statute one ounce of gold is priced at $42.22; this number differs starkly from the market price of gold.</p>
<p>According to the Department of the Treasury, the U.S. Treasury <a href="http://www.gao.gov/financial/fy2010/10frusg.pdf">holds roughly</a> 264.3 million troy ounces of gold, marked at a value of $42 per ounce, giving a reported value of $11.1 billion at the end of fiscal year 2010. However, if the total U.S. gold holdings were valued at the recent spot price of $1,500 per ounce, they would be valued at near $400 billion.</p>
<p>That is certainly a significant amount of money, but $400 billion still would not cover the debt (not that we shouldn&rsquo;t sell the reserves if we need to). More importantly, any attempt to sell our reserves would drive down the price of gold by flooding the market.</p>
<p><em>Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a>&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University. This column <a href="http://reason.com/archives/2011/05/16/the-facts-about-gold">first appeared</a> at Reason.com.<br /></em></p>1011669@http://www.reason.orgMon, 16 May 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)Ugly Modelinghttp://www.reason.org/news/show/ugly-modeling
<p>In February, the Goldman Sachs economist Alec Phillips predicted on ABCNews.com that a Republican proposal in the House of Representatives to cut $61 billion from the federal budget in fiscal year 2011, would, if enacted, shave two full percentage points off America&rsquo;s gross domestic product in the second and third quarters of this year. A few days later, <em>The Washington Post</em> described a new study by Mark Zandi, the chief economist at Moody&rsquo;s Analytics and an architect of the 2009 stimulus package, a.k.a. the American Recovery and Reinvestment Act. Zandi&rsquo;s amazing verdict: The spending cuts would destroy 700,000 jobs by the end of 2012.</p>
<p>After every newspaper had published the gloomy predictions, Goldman Sachs issued a &ldquo;clarification&rdquo; of Phillips&rsquo; analysis. Phillips now says he was misunderstood by journalists eager to spread a doom-and-gloom message and predicts the impact of spending cuts probably will be mild and temporary. Perhaps he was influenced by Federal Reserve Chairman Ben Bernanke, who testified in March at the Senate Banking and Urban Affairs Committee that Goldman&rsquo;s numbers were incorrect.</p>
<p>Yet even this correction implicitly assumes that government spending is the source of all recovery. The logic, as with Bernanke&rsquo;s and Zandi&rsquo;s analyses, is that government spending cuts reduce overall demand in the economy, which affects growth and then employment. This argument ignores the fact that the government has to take its money out of the economy by raising taxes, borrowing from investors, or printing dollars. Each of these options can shrink the economy.</p>
<p>All these analysts also systematically ignore the fact that GDP numbers include government spending. When the federal government pumps trillions of dollars into the economy, it looks as if GDP is growing. When government cuts spending&mdash;even cuts within the most inefficient programs&mdash;aggregate GDP shrinks.&nbsp;</p>
<p>But that&rsquo;s misleading. If Washington spends $1 a year on a bureaucrat&rsquo;s salary, for example, GDP numbers will register growth of exactly $1, whether or not the employee has produced any value for that money. By contrast, if a firm pays an engineer $1, that $1 only shows up in the GDP if the engineer produces $1 worth of stuff to sell. This distinction biases GDP numbers&mdash;and the policies based on them&mdash;toward ever-increasing government spending.</p>
<p>Furthermore, GDP does not capture changes in personal investment portfolios or changes in private research and development spending. In the last two years, corporate cuts in the latter area have been large but unaccounted for. Also not included in GDP: pension benefits and the U.S. Flow of Funds Accounts balance-sheet information from the Federal Reserve Board. That means that when it comes to GDP, states&rsquo; grossly underfunded pensions are off the books, along with the loans and purchases conducted under TARP.</p>
<p>Another problem with these analyses: Economists of all persuasions have proven to be really bad at predicting the future, especially when it comes to jobs. Take the stimulus. Forecasters at the White House and the Congressional Budget Office (CBO) predicted the stimulus package would create more than 3 million jobs. And in August 2010, the CBO estimated that the stimulus had indeed created between 1.4 million and 3.6 million extra jobs, thrilling supporters of economic intervention. But unemployment stubbornly remained around 10 percent.</p>
<p>What was wrong with the CBO&rsquo;s numbers? &ldquo;When the upper limit of your estimate is almost three times the lower limit, you know it is not a very precise estimate,&rdquo; the George Mason University economist Russ Roberts pointed out in testimony to the House Subcommittee on Regulatory Affairs, Stimulus Oversight, and Government Spending in February.</p>
<p>The truth is that there is no way to know the real number of jobs &ldquo;created or saved&rdquo; by the stimulus. For that, the CBO would have had to collect data on output and employment while holding other factors constant. But the CBO didn&rsquo;t do that because that&rsquo;s different from its job of &ldquo;scoring&rdquo; the possible results of proposed legislation. As the CBO explained in a November 2009 report, &ldquo;Isolating the effects would require knowing what path the economy would have taken in the absence of the law. Because that path cannot be observed, the new data add only limited information about [the law&rsquo;s] impact.&rdquo; In other words, CBO number crunchers gave it their best guess before the stimulus and arrived at their subsequent numbers by applying their original prediction model. If the model is wrong, so are the numbers.</p>
<p>No one knows what economic output would have been without the stimulus, and no models can tell us the answer. As Roberts testified, &ldquo;The economy is too complex. Too many other variables change at the same time.&rdquo;&nbsp;</p>
<p>Also, the Zandi and Phillips models are based on the Keynesian view that government spending produces recovery. According to that theory, $1 in government spending produces substantially more than $1 in growth, a phenomenon known as the &ldquo;multiplier effect.&rdquo; The Goldman Sachs study assumes a multiplier greater than three&mdash;i.e., more than $3 in additional GDP for each dollar of government spending. But a review of the empirical literature reveals that in most cases a dollar in government spending produces less than a dollar in economic growth. And these findings often don&rsquo;t even take into account the impact of paying for that government dollar via increased taxes.&nbsp;</p>
<p>The Harvard economists Robert Barro and Charles Redlick estimate that the multiplier for stimulus spending is between 0.4 and 0.7. In another study, the Stanford economists John Taylor and John Cogan concluded that the stimulus package couldn&rsquo;t have had a multiplier much greater than zero. Even the multipliers used by Christina Romer, the former chairwoman of the White House Council of Economic Advisers, and Jared Bernstein, economic adviser to Vice President Joseph Biden, in their January 2009 paper &ldquo;The Job Impact of the American Recovery and Reinvestment Plan,&rdquo; ranged from 1.05 to 1.55 for the output effect of government purchases. More recently, the Dartmouth economists James Feyrer and Bruce Sacerdote, who supported the stimulus, acknowledged that it didn&rsquo;t boost the economy nearly as much as the administration models claimed it would.</p>
<p>The use of these outdated models and unrealistic multipliers explains why Zandi was wrong about how many jobs the stimulus would create. He claimed &ldquo;the country will have 4 million more jobs by the end of 2010&rdquo; if the stimulus passed. In truth, by the end of 2010 total payroll jobs had fallen by 3.3 million, and the unemployment rate had risen from 7.8 percent to 9.4 percent. The administration&rsquo;s post-facto claim is that unemployment would have risen even more without the stimulus. To argue this, they again must pretend that they know what would have happened in the absence of a stimulus.</p>
<p>Now what? Many economists and many members of the business community argue that recent policy changes have hampered investment, making a bad situation worse. The prospect of endless future deficits and accumulating debt raises the threats of increased taxes and of government borrowing crowding out capital markets, diverting resources that could be used more productively. As a result, U.S. companies are less likely to build new plants, conduct research, and hire people.</p>
<p>We have tried spending a lot of money to jump-start the economy, and it has failed. Now we need to cut spending and lift the uncertainty paralyzing economic activity. That approach will not just be more fiscally responsible. It will also empower individuals and entrepreneurs. And they are the only ones who can bring on a real recovery.&nbsp;</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> (vderugy&#64;gmu.edu), a senior research fellow at the Mercatus Center at George Mason University, writes a monthly economics column for</em> <strong>reason. </strong><em>This column <a href="http://reason.com/archives/2011/05/10/ugly-modeling">first appeared</a> at Reason.com.</em></p>1011644@http://www.reason.orgTue, 10 May 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Facts About the Corporate Income Taxhttp://www.reason.org/news/show/the-facts-about-the-corporate-incom
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<p><em>Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>We can collect more revenue by raising the tax rate on corporations or by increasing the top bracket.</em></p>
<p><strong>Fact 1:&nbsp;</strong> <em>The wealth of the economy is a much better indicator of corporate tax revenue than tax rates and tax brackets.</em></p>
<p>&#65279;<img src="http://reason.com/assets/mc/ngillespie/2011_05/topcorporaterate.jpg" border="0" width="450" height="328" /></p>
<p>This chart shows the corporate tax collection as a share of the economy side by side with the top marginal corporate rate since 1981. During that time, the U.S. corporate tax rate has been as high as 46 percent and has gone down to 34 percent. Since 1993, the top rate has been 35 percent. The level of income covered by the top tax bracket has varied a lot too: from $100,000 in 1981 to $1.4 million in 1984, down to $335,000 in 1987 and up again to $18 million since 1993 (all dollar amounts in nominal terms).</p>
<p>This chart makes clear that the general state of the economy is a much better indicator of the tax collection than rate levels and the top bracket. It is particularly visible since 1993, since the rate and top bracket haven&rsquo;t changed and yet tax collection varied a great deal, falling during recessions and rising during recoveries.</p>
<p><strong>Myth 2:</strong> <em>Corporations pay the corporate income tax.</em></p>
<p><strong>Fact 2:</strong> <em>First, corporations do not pay taxes, only individuals pay taxes. More importantly, economists have shown that a majority of the corporate income tax is borne by labor mainly in the form of lower wages rather than borne by shareholders.</em></p>
<p><img src="http://reason.com/assets/mc/ngillespie/2011_05/topstaturyrate.jpg" border="0" width="450" height="331" /></p>
<p>This chart (overly simplified for the Bloomberg discussion) is based on <a href="http://www.aei.org/docLib/SpatialTaxCompetitionandDomesticWages.pdf"> academic work</a>&nbsp;done by Aparna Mathur and Kevin Hassett in December 2010 and shows the link between corporate tax rates and the average manufacturing wage (in U.S. dollars) for 65 countries between 1981 and 2005. It shows a negative link between tax rates and wages, suggesting that higher corporate tax rates lead to lower worker wages. Mathur and Hassett test this point by using regressions controlling for other factors. They find that a 1 percent increase in the corporate income tax leads to almost a 0.5-0.6 percent decrease in hourly wages.</p>
<p>Interestingly, a chart from their original <a href="http://www.aei.org/paper/24629">2006 paper</a> shows that when the sample of countries is restricted to Organization for Economic Cooperation and Development (OECD) member countries, the negative slope is much more pronounced. That implies that higher corporate taxes have a stronger negative impact on wages in developed economies.</p>
<p>This is consistent with a growing body of work [see Arulampalam et al. (2007), Mihir A. Desai, C. Fritz Foley, and James R. Hines (2007), and Felix (2007)] that analyzes actual payroll data to see who in fact is bearing the corporate income tax. Such work finds a large impact of corporate income tax on labor&mdash;as high at 200 percent. The theoretical studies that followed found a lower but still large impact on wages from the corporate income tax. These studies show that from 45 to 75 percent of the cost of the corporate tax is borne by labor rather than shareholders, as has long been believed.</p>
<p>Here is <a href="http://www.cbo.gov/ftpdocs/75xx/doc7503/2006-09.pdf">the Congressional Budget Office&rsquo;s William Randolph</a> (2006) for instance:</p>
<blockquote>
<p>Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden. Domestic landowners receive a small benefit. At the same time, the foreign owners of capital bear slightly more than 70 percent of the burden, but their burden is exactly offset by the benefits received by foreign workers and landowners.</p>
</blockquote>
<p><strong>Myth 3:&nbsp;</strong> <em>The United States is a friendly country for businesses.</em></p>
<p><strong>Fact 3:</strong> <em>Not really. While there is good access to capital, the U.S. has the top corporate income tax rate among OECD nations and a worldwide tax system.</em></p>
<p><img src="http://reason.com/assets/mc/ngillespie/2011_05/topintlrates.jpg" border="0" width="450" height="328" /></p>
<p>In 2010, the top national corporate tax rates among the 31 members of the OECD ranged from 8.5 percent in Switzerland to 35 percent in the United States. Hence, within the OECD countries, the United States has the highest statutory tax rate at the national level. The picture changes only slightly when we add subnational or state-level corporate tax rates to the national rate. In the United States, the average top statutory rate imposed by states in 2010 added a bit over 4 percent (after accounting for the fact that state taxes are deducted from federal taxable income) for a combined top statutory rate of 39.2 percent. Among all OECD countries in 2010, the United States had the second-highest top statutory combined corporate tax rate, after Japan&rsquo;s rate of 39.5 percent.</p>
<p>Interestingly, the U.S. corporate income tax raises little revenue compared with other taxes and this share has decreased over the years. It's not surprising, then, that the U.S. raises less revenue from the corporate tax than <a href="http://www.oecd.org/document/60/0,3746,en_2649_34533_1942460_1_1_1_1,00.html#A_RevenueStatistics"> the OECD average</a>. Corporations, like individuals, can and do use tax breaks to lower their tax burdens and, as a result, the effective tax rate is lower than the top rate.</p>
<p>However, these breaks shouldn&rsquo;t be looked at independently of the corporate tax system. As it turns out, the U.S. not only imposes high rates, it also taxes corporations <a href="http://reason.com/archives/2009/07/14/destroying-jobs-in-order-to-sa"> on a worldwide basis</a>. So, for example, profits made by an American-owned computer plant are subject to U.S. taxes whether the plant is located in Texas or Ireland. Most major countries don&rsquo;t tax foreign business income. In fact, about half of OECD nations have &ldquo;territorial&rdquo; systems that tax firms only on their domestic income.</p>
<p>As I explained a few years ago in <a href="http://reason.com/archives/2009/07/14/destroying-jobs-in-order-to-sa"> <em>Reason</em> magazine</a>, the combination of high <a href="http://reason.com/archives/2009/07/14/destroying-jobs-in-order-to-sa"> rates</a>, the worldwide tax system, and a competitive global marketplace makes the U.S. corporate tax system more punishing than it seems even on first glance.&nbsp;</p>
<p><em>Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu" title="[GMCP] Compose a new mail to Veronique de Rugy">Veronique de Rugy</a>&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University. This column <a href="http://reason.com/archives/2011/05/06/the-facts-about-the-corporate">first appeared</a> at Reason.com.<br /></em></p>1011633@http://www.reason.orgFri, 06 May 2011 15:00:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Taxes and Redistributionhttp://www.reason.org/news/show/the-truth-about-taxes-and-redistrib
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<p><em>Editorâ??s Note: ReasonÂ <a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>Â andÂ <a href="http://mercatus.org/">Mercatus Center</a>Â economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.<br /> Â </em></p>
<p><strong>Myth 1: The wealthy arenâ??t paying their fair share.</strong></p>
<p><strong>Fact 1: The wealthy disproportionately fund the United States federal government.</strong></p>
<p><img src="http://reason.com/assets/mc/mmoynihan/2011_04/vero1.png" border="0" width="409" height="297" /></p>
<p>As you can see, the top earning 1 percent of Americans (or 1.4 million returns making more than $380,000) paid 38 percent of federal personal income taxes. However, they made only 20 percent of income. Â The top 5 percent of income earners pay almost 60 percent of income taxes and make almost 35 percent of all personal income.Â The Americans at the lower half of the income spectrum (or 70 million returns) paid 2.7 percent of the total. This chart also shows that roughly half of taxpayers pay for almost all of the federal personal income taxes.</p>
<p>It means that the income tax in America is extremely progressive.</p>
<p>This week, E.J. Dionne'sÂ <em>Washington Post</em> <a href="http://www.washingtonpost.com/opinions/americas-elites-have-a-duty-to-the-rest-of-us/2011/04/16/AF5KN8vD_story.html"> column</a>Â quoted writer David Cay Johnston: "The effective rate for the top 400 taxpayers has gone from 30 cents on the dollar in 1993 to 22 cents at the end of the Clinton years to 16.6 cents under Bush. So their effective rate has gone down more than 40 percent.â?</p>
<p>In fact, the top 400 aren't a static group. There's lots of income mobility in and out of the "top 400" every year, and most of their income is due to highly fluctuating capital gains (which is taxed lower than ordinary income).Â IRS data for the top 400 over a 15-year period show that 72 percent of them appeared only <em>once</em>.Â A little more than 12 percent appeared twice and a little over 15 percent appear three times or more. Trying to fine tune tax policy to attack the "top 400" will only tax different people tomorrow than are there today.</p>
<p><strong>Myth 2:Â Top earners in the United States are millionaires.</strong></p>
<p><strong>Fact 2: Only 2% of the top 10% of earners are millionaires.</strong></p>
<p><strong>Â <img src="http://reason.com/assets/mc/mmoynihan/2011_04/vero2.png" border="0" width="300" height="218" /></strong></p>
<p>When Americans think of the top earners in the United States, they often overstate the earnings of those with the highest reported earnings.Â The top 10 percent of United States tax returns report $114,000 in earnings, the top 5 percent of households report $169,000 in earnings, and the top 1 percent report $380,000.</p>
<p>Furthermore, these earnings should be taken in their geographic context.Â This chart shows what a worker would need to earn in each of 5 different cities in order to maintain the same standard of living as a person living in DC making $250,000.</p>
<p>As we can see, it takes roughly $170K in Kansas or Georgia to have the standard of living of someone making a $250,000 in Washington DC. However, to have that standard of living in New York, you need almost $400,000.</p>
<p><strong><span><img src="http://reason.com/assets/mc/mmoynihan/2011_04/vero3.png" border="0" width="400" height="291" /><br /></span></strong></p>
<p><strong>Myth 3:Â All Americans pay income taxes.</strong></p>
<p><strong>Fact 3:Â An estimated 45% of Americans will pay no federal income taxes this year.Â </strong></p>
<p><strong><img src="http://reason.com/assets/mc/mmoynihan/2011_04/vero4.png" border="0" width="400" height="296" /></strong></p>
<p>According to the Tax Policy Center, this tax season, an estimated 45 percent of tax units will pay no federal income taxes. In 2009, federal non-income taxpayers were distributed throughout the earnings spectrum, with 26.3 percent of tax returns reporting less than $10,000 paying no income tax, 29.1 percent of those making between $10,000 and $20,000 paying no income tax; the remaining 44.6 percent of Americans not paying income taxes were distributed throughout all cash income levels.</p>
<p><strong>Myth 4: The key to our deficit problems rests in our ability to increasing the top marginal tax rates leads to increased tax revenues</strong></p>
<p><strong>Fact 4: From 1930 to 2010, tax revenue collection in the United States has never topped 20.9 percent, averaging 16.5 percent of GDP over these 80 years - despite drastic fluctuations in the rate of taxes on the wealthiest Americans.</strong></p>
<p><strong><img src="http://reason.com/assets/mc/mmoynihan/2011_04/vero5.png" border="0" width="400" height="289" /></strong></p>
<p>This chart shows the historical path of federal taxation as a percentage of GDP using the earliest records available from the Office of Management and Budget and top marginal tax rate data from the Tax Policy Center. In red, the historical path of the highest marginal income tax rates (right axis), in green, historical federal revenues as percentages of GDP (left axis).Â From 1930 to 2010, tax revenue collection in the United States has never topped 20.9 percent of GDP, averaging 16.5 percent of GDP over these 80 years.</p>
<p>This comes despite the drastic historical fluctuation in the rate of taxes on the wealthiest Americans.</p>
<p>During the time period examined above, the rate of income taxation on the highest earning Americans has fluctuated drastically, from 25 percent of income in 1930 to 92 percent of income in the early 1950â??s. Despite these vast differences in these top marginal rates, the total percentage of GDP the federal government has collected in revenue has changed little.</p>
<p>The bottom line is that any claim that the revenue problems could be solved by raising revenue as a percentage of the economy above 19 percent is unrealistic. Also, raising the top marginal rates has never proven to generate sustainable increase in revenue.</p>
<p><em>Contributing EditorÂ <a href="mailto:vderugy&#64;gmu.edu" title="[GMCP] Compose a new mail to Veronique de Rugy">Veronique de Rugy</a>Â is a senior research fellow at theÂ <a href="http://mercatus.org/">Mercatus Center</a>Â at George Mason University. This column <a href="http://reason.com/archives/2011/04/22/the-truth-about-taxes-and-redi">first appeared</a> at Reason.com.<br /></em></p>
1011574@http://www.reason.orgFri, 22 Apr 2011 15:00:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Health Care Reform and the Economyhttp://www.reason.org/news/show/the-truth-about-health-care-reform
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<p><em>Editor&rsquo;s Note: Reason <a href="http://reason.com/people/veronique-de-rugy/all">columnist</a> and <a href="http://mercatus.org/">Mercatus Center</a> economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Health care reform will reduce the deficit.</em></p>
<p><strong>Fact 1:</strong> <em>Health care reform will increase the deficit.</em></p>
<p>The Patient Protection and Affordable Care Act includes many provisions that have nothing to do with health care: the CLASS act, a student loan overhaul, and many new taxes. These provisions don't change the health care system. They just raise money to pay for the new law. Strip them away and the law&rsquo;s actual health care provisions don't lower the deficit&mdash;they increase it!</p>
<p>The chart below uses data from Congressional Budget Office (CBO) to clarify the fiscal consequences of health care reform. &nbsp;</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohc1.jpg" border="0" width="417" height="316" /></p>
<p>As you can see, from 2012 to 2021, the Congressional Budget Office estimates that the health care act will reduce deficits by $210 billion (note that this estimate differs from the widely cited $143 billion figure used during the lead-up to the passage of the act). During this same time period, however, the actual health care reform provisions of the law will increase deficits by $464 billion.</p>
<p>Of course, one should not evaluate the health care legislation on its fiscal impacts alone. In theory we should get some fiscal benefits. But the key question is how they net out. Still, no matter what you think about the benefits of the health care legislation, it is incorrect to claim that health care reform will save money. It won&rsquo;t.</p>
<p><strong>Myth 2:</strong> <em>The U.S. health care system is a free-market system.</em></p>
<p><strong>Fact 2:</strong> <em>Roughly half of all U.S. health care is currently paid for by the government.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohc2.jpg" border="0" width="458" height="301" /></p>
<p>Even in the absence of the health care reform law, government programs including Medicare and Medicaid already fund almost half of American health care. Roughly a third of the remaining expenditures are funded by private insurers&mdash;mainly through subsidized and highly regulated employee plans. Not exactly a free market.</p>
<p>As this chart shows, state and federal entities make up over half of the health insurance market. Of course, the Patient Protection and Affordable Care Act will only increase the share of government involvement in the health care market.</p>
<p><strong>Myth 3:</strong> <em>Medicare spending increases life expectancy for seniors. Reductions in Medicare spending will therefore reduce their life expectancy.</em></p>
<p><strong>Fact 3:</strong> <em>Increases in life expectancy for seniors are due to increased access to health care, not to Medicare.</em></p>
<p>While Medicare spending has certainly decreased seniors&rsquo; out of pocket health care expenses (by 1970, Medicare reduced out of pocket expenses by an estimated 40 percent relative to pre-Medicare levels), the program&rsquo;s effect on mortality is much less clear.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohc4.jpg" border="0" width="632" height="407" /></p>
<p>This chart compares mortality rates by age during the periods immediately before and after Medicare&rsquo;s implementation. As you can see, there is little difference in the observed mortality of men and women during these time periods. This observation is supported by the economic literature.</p>
<p>Economists who examine the effects of Medicare on mortality have found little evidence of a causal relationship, especially in recent years. For example, MIT&rsquo;s Amy Finkelstein and Wellesley&rsquo;s Robin McKnight used several empirical approaches and found no evidence that Medicare played a role in the substantial declines in elderly mortality that followed its implementation. Instead, they write, their evidence suggests that,</p>
<blockquote>
<p>the explanation lies in the fact that, prior to Medicare, lack of legal access&mdash;rather than lack of insurance&mdash;was the main barrier to receiving hospital care when individuals had life threatening, treatable conditions.</p>
</blockquote>
<p>Other economists, writing at the Chicago Federal Reserve, have found that Medicare did reduce mortality rates immediately following its implementation. But they also found that the effects of Medicare on mortality have been diminishing ever since. These researchers found that by the mid-1980s, there is no evidence of Medicare having any effect on mortality. As legal access to the health insurance market for the elderly has expanded over time, whatever effect Medicare once may have had on mortality has since disappeared.</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> is a senior research fellow at the <a href="http://mercatus.org/">Mercatus Center</a> at George Mason University. This column <a href="http://reason.com/archives/2011/04/15/the-truth-about-health-care-re">first appeared</a> at Reason.com.<br /></em></p>1011536@http://www.reason.orgFri, 15 Apr 2011 18:00:00 EDTvdereugy@gmu.edu (Veronique de Rugy)A Bankrupt Optionhttp://www.reason.org/news/show/a-bankrupt-option
<div>The 50 states, as we have seen recently in Wisconsin and elsewhere, are in serious fiscal trouble. Total state debt is estimated at more than $1 trillion, and that doesn't include another $3 trillion in unfunded liabilities from pensions and other obligations. We can afford neither a federal bailout of this sum nor the precedent it would set. But how about giving states the option of filing for bankruptcy, as municipalities can do via Chapter 9?</div>
<div><br /></div>
<div>University of Pennsylvania law professor David Skeel, a specialist in corporate finance and bankruptcy, thinks that's a good idea. Writing in The Weekly Standard last November, he argued that a procedure for bankruptcy could instantly reduce states' bond debt and chop the fat out of bloated contracts with public employees by allowing states in default or in danger of default to reorganize their finances free from their contractual obligations. In January former House Speaker Newt Gingrich and former Florida Gov. Jeb Bush endorsed the concept in the Los Angeles Times, arguing that a new law could give states a chance to reform their unaffordable and underfunded pension systems. In "a voluntary bankruptcy scenario," they wrote, "states, like municipalities, will have every incentive to file a reorganization plan that protects state bondholder claims and their ultimate recovery."</div>
<div><br /></div>
<div>Critics contend that bankruptcy will only make states' problems worse by jeopardizing their ability to borrow and finance their debt. Paul Maco, who was head of the Securities and Exchange Commission's Office of Municipal Securities during the Clinton administration, told The New York Times that even introducing a state bankruptcy bill could precipitate "some kind of market penalty." As the Timessummarized Maco's argument, that penalty "might be higher borrowing costs for a state and downward pressure on the value of its bonds. Individual bondholders would not realize any losses unless they sold.&hellip;A deeply troubled state could eventually be priced out of the capital markets." According to Reuters, the ratings agency Standard &amp; Poor's believes that the potential "market penalty" for bankruptcy would be so large that states would be discouraged from even considering the option. Bush and Gingrich responded to that argument by saying states would "consider their long-term lending potential and credit worthiness" in restructuring, thus minimizing the costs.</div>
<div><br /></div>
<div>Unlike some critics of state bankruptcy, I think state borrowing should be priced accurately by the bond market for the risk it represents, even if it leads to some defaults. That beats the current situation, where investors are under the illusion that states are too big to fail. But such a readjustment in interest rates shouldn't be brought about by rewriting bankruptcy law in a way that could delay needed reforms.&nbsp;</div>
<div><br /></div>
<div>Constitutionally, states cannot be forced into bankruptcy by their creditors or the federal government. That means even if a bankruptcy law was adopted, any proceeding would have to be initiated by state legislatures voluntarily. But what makes us think they would do that? As Manhattan Institute economist E.J. McMahon put it in The Wall Street Journal in January, "if Gov. Jerry Brown and the California legislature are unwilling to rewrite their collective bargaining rules&mdash;signed into law by Mr. Brown himself, 33 years ago&mdash;why assume they would plead with a federal judge to do it for them?"</div>
<div><br /></div>
<div>In many states, bankruptcy will be an option only if powerful unions and other entrenched interest groups see it as a way to force budget problems onto the state's bondholders rather than public employees. Bankruptcy in these conditions would allow the state to continue budgeting under the same structure as before, basically giving statehouses a clean slate without providing incentives to change the core of their financial problems: overspending in education, excessive public pensions and benefits, and a swollen state work force. You wouldn't want to pay down your sister's credit card balance without taking away her ability to pile up new debt.</div>
<div><br /></div>
<div>Local governments already have the power to go bankrupt, and the results to date have not been inspiring. For the most part it hasn't helped them address problems of overspending, red tape, federal mandates, and unfunded liabilities. Vallejo, California, is a case in point. A few years ago, a bankruptcy judge gave city leaders the authority to void union contracts in their effort to reorganize under the crushing load of public-sector compensation. But nothing happened.</div>
<div><br /></div>
<div>The good news is that states have other options for forcing concessions from powerful public employee unions. One is, in McMahon's words, "the threat of mass layoffs, which most governors can impose unilaterally. Governors and legislators also can prospectively freeze wages or even cut them through involuntary furloughs, as California and several other states did over the past two years."</div>
<div><br /></div>
<div>Another reform would be to remove the protections that allow state workers to collectively bargain for wages and benefits, giving lawmakers more leeway during negotiations and opening the door to privatization. Some 18 states already bar some categories of government employees from collective bargaining, and Virginia and North Carolina prohibit it for all public workers. Indiana Gov. Mitch Daniels did away with all public employees' power to bargain collectively through an executive order in 2005. In other states&mdash;such as Wisconsin, where at press time Gov. Scott Walker is trying to limit collective bargaining&mdash;decommissioning requires action by the legislature.</div>
<div><br /></div>
<div>States also could improve their pension systems through accounting reforms and by switching from defined-benefit plans to defined-contribution plans, in which employees' benefits reflect the amount of money they or their employers deposit in their accounts. The federal government could adopt block grants for Medicaid, which would provide a fixed sum to states and give them flexibility on program design. There is no shortage of reforms that would help restore some fiscal sense to the states. But they will require hard political work to pass.</div>
<div><br /></div>
<div>Bankruptcy may sound like a silver bullet that could solve budget woes, dismantle cronyism, fix pensions, and forestall a federal bailout. But it contains plenty of potentially counterproductive consequences. Restoring the states' fiscal health requires fundamental changes to the way they do business. Until that happens, their balance sheets will be bleeding red ink, whether they are officially bankrupt or not.&nbsp;</div>
<div><br /></div>
<div><em>Contributing Editor Veronique de Rugy (vderugy&#64;gmu.edu), a senior research fellow at the Mercatus Center at George Mason University, writes a monthly economics column for reason. This column first appeared at Reason.com.</em></div>
<div><br /></div>1011509@http://www.reason.orgTue, 12 Apr 2011 10:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Spending Cutshttp://www.reason.org/news/show/the-truth-about-spending-cuts
<p>
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<p><em style="font-style: italic;">Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong style="font-weight: bold;">Myth 1:</strong>&nbsp;<em style="font-style: italic;">Spending cuts will derail the economy.</em></p>
<p><strong style="font-weight: bold;">Fact 1:</strong>&nbsp;<em style="font-style: italic;">The academic literature shows that successful cases of fiscal adjustment relied overwhelmingly on spending cuts, not tax increases.</em></p>
<p>While the political debate heats up over the short-term effects of spending cuts, there is a wide academic consensus that spending cuts are a major factor for achieving lasting debt reduction. In particular, empirical studies have shown that fiscal consolidations based upon spending cuts have been more effective than tax-based consolidations.</p>
<p>This chart consolidates data from five peer-reviewed studies examining the ratio of spending cuts to revenue measures in successful fiscal consolidations. It illustrates that the average successful fiscal consolidation was comprised of 80 percent spending cuts and 20 percent revenue measures.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/cuts1.jpg" border="0" width="503" style="border: 0px initial initial;" height="362" /></p>
<p>An independent&nbsp;<a href="http://www.aei.org/docLib/20101227-Econ-WP-2010-04.pdf">analysis</a>&nbsp;performed by the American Enterprise Institute economists Andrew Biggs, Kevin Hassett, and Matthew Jensen confirms the literature&rsquo;s finding that fiscal consolidations that reduce ratios of debt to GDP tend to be based upon reduced government outlays rather than increased tax revenues. This result holds whether fiscal consolidations are defined in terms of improvements in the cyclically-adjusted primary budget deficit or in terms of pre-meditated policy changes designed to improve the budget balance.</p>
<p>Biggs, Hassett, and Jensen reviewed the extensive existing literature on fiscal consolidations. They also conducted their own data analysis to study that question. They used a large data set covering over 20 Organization for Economic Co-Operation and Development countries and spanning nearly four decades to isolate over 100 instances where countries took steps to address their budget gaps. Some of these fiscal consolidations were spending-based while others relied more on taxes. Here is what they found:</p>
<blockquote>
<p>Our findings are striking: countries that addressed their budget shortfalls through reduced spending were far more likely to reduce their debt than countries whose budget-balancing strategies depended upon higher taxes.</p>
</blockquote>
<p>The typical unsuccessful fiscal consolidation consisted of 53 percent tax increases and 47 percent spending cuts. By contrast, the typical successful fiscal consolidation consisted of 85 percent spending cuts. These results are consistent with a large body of peer-reviewed research.</p>
<p>These findings are also consistent with&nbsp;<a href="http://www.nber.org/chapters/c11970">the research</a>&nbsp;of Harvard&rsquo;s Alberto Alesina and Silvia Ardagna (here&nbsp;is&nbsp;<a href="http://mercatus.org/publication/fiscal-adjustments-what-do-we-know-and-what-are-we-doing">another paper</a>&nbsp;by Alesina on the issue).</p>
<p>The debate, of course, is far from settled. Yet as Biggs&nbsp;<a href="http://waysandmeans.house.gov/UploadedFiles/Biggs_--_Ways_and_Means_Testimony.pdf">explained</a>&nbsp;in his March 30, 2011 testimony before the House Ways and Means Committee:</p>
<blockquote>
<p>[The debate] is not about whether spending-based fiscal consolidations are more likely to succeed than tax-based consolidations. Even using the IMF study&rsquo;s methods, spending-based consolidations are more likely to reduce deficits and debt than tax-based consolidations.</p>
</blockquote>
<blockquote>
<p>Second, the IMF study does not dispute that spending-based fiscal consolidations generate superior short-term economic outcomes than tax-based consolidations.</p>
</blockquote>
<p>In other words, the least we can say about fiscal consolidations comprised primarily of spending cuts is that they shrink both deficits and the debt. In that context it is worth pointing to the work&nbsp;of former Obama administration Council of Economic Advisers Chair Christina Romer and her economist husband David Romer, which shows that increasing taxes by 1 percent of GDP for deficit-reduction purposes leads to a 3 percent reduction in GDP.</p>
<p><strong style="font-weight: bold;">Myth 2:</strong>&nbsp;<em style="font-style: italic;">We can&rsquo;t balance the budget without raising taxes.</em></p>
<p><strong style="font-weight: bold;">Fact 2:</strong>&nbsp;<em style="font-style: italic;">We can balance the budget simply by holding spending constant.</em></p>
<p>Fiscal balance can be achieved by holding spending constant, and by driving it toward its historical equilibrium.</p>
<p>In&nbsp;<em style="font-style: italic;">Reason</em>&nbsp;magazine&rsquo;s March issue, Nick Gillespie and I proposed&nbsp;<a href="http://reason.com/archives/2011/02/14/the-19-percent-solution/singlepage">a 10-year balanced budget plan</a>&nbsp;that would systematically reduce the projected growth in outlays (spending that hasn&rsquo;t occurred yet and hasn&rsquo;t even been appropriated) so that it equals the 19 percent of GDP that the Congressional Budget Office projects the federal government will raise as revenue if the current tax system is left unchanged. Effectively, under this plan, spending is frozen at its current levels and allowed to grow only for inflation. See the chart below.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/cuts2.jpg" border="0" width="427" style="border: 0px initial initial;" height="314" /></p>
<p>In other words, we can balance the budget over the next decade without raising taxes if we ratchet down spending from its current level of 25 percent of GDP to 19 percent -- a figure that would still leave spending well above the 18.2 percent of GDP that President Bill Clinton spent in his last year in office, a time when no one was complaining about a skin-flint federal government.</p>
<p>Another solution would be for Congress and the president to agree to reduce 1 percent from the federal budget each year until balance is reached. As my Mercatus Center colleague Jason Fichtner explains in<a href="http://mercatus.org/publication/1-percent-solution">this paper</a>, the 1 percent reduction would be a real cut in spending, not just a reduction in the rate of growth of government. Once a balanced budget is reached, then spending could again be allowed to grow, but at rates consistent with the growth in the overall economy so that relative fiscal balance is maintained. A 1 percent reduction in spending does not necessarily mean a 1 percent cut across the board. Under this plan, Congress could still set priorities.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/cuts3.jpg" border="0" width="426" style="border: 0px initial initial;" height="310" /></p>
<p>As Gillespie and I explained earlier this week in&nbsp;<a href="http://reason.com/archives/2011/04/06/paul-ryans-republican-budget-t/singlepage">our piece</a>&nbsp;assessing Rep. Paul Ryan&rsquo;s (R-Wisc.) Path To Prosperity plan,</p>
<blockquote>
<p>if cuts such as these are not possible, it would be better to give up any pretense that we will ever restore the barest semblance of sanity to the federal budget and get on with fiddling as Rome burns. If we're going to continue hosting a party whose bill is unpayable, we might as well enjoy ourselves.</p>
</blockquote>
<p><strong style="font-weight: bold;">Myth 3:</strong>&nbsp;<em style="font-style: italic;">Paul Ryan&rsquo;s plan will dramatically cut spending.</em></p>
<p><strong style="font-weight: bold;">Fact 3:</strong>&nbsp;<em style="font-style: italic;">Ryan&rsquo;s plan reduces spending between FY2011 and FY2012. After that it reduces the growth of spending. But overall spending grows by $1.1 trillion over 10 years under Ryan&rsquo;s plan.</em></p>
<p>At first glance, House Budget Chairman Paul Ryan&rsquo;s&nbsp;<a href="http://budget.house.gov/UploadedFiles/PathToProsperityFY2012.pdf">FY2012 Budget Resolution</a>&nbsp;is a step in the right direction. With a determined moniker, &ldquo;The Path to Prosperity,&rdquo; the Republican roadmap is oriented on spending cuts, debt reduction, and credible revenue expectations.</p>
<p>The plan is not too surprising to those of us who have followed Ryan&rsquo;s previous budget crusades. It concentrates on cutting government spending--reforming two of our three largest autopilot programs, Medicare and Medicaid--while recognizing that attempts at raising tax revenue will not support economic growth or fix our spending problem.</p>
<p>The new plan realistically projects that tax revenue as a percentage of the economy will grow as a result of economic growth and not from tax rate hikes. Under Ryan&rsquo;s plan tax revenue will consume 17.1 percent of the wealth created by American families, a number that is more in line with the government&rsquo;s abilities to collect money. This is a serious improvement over the Deficit Commission&rsquo;s plan, which called for reducing the deficit by raising tax revenue to an unprecedented 21 percent of GDP--an approach that is little more than wishful thinking on the part of its authors.</p>
<p>However, a look at the data shows that while the Ryan plan will cut spending the first year, it then proceeds to slow down the rate of spending. In nominal terms, spending increases from $3.6 trillion in 2011 to $4.7 trillion in 2021. That equates to a $1.1 trillion increase over that period.</p>
<p>Of course, you wouldn&rsquo;t know that anything about those spending increases under the Ryan plan if you only read the recent headlines&nbsp;<a href="http://www.washingtonpost.com/opinions/the-end-of-progressive-government/2011/04/01/AFQbjTXC_story.html">wailing about</a>&nbsp;"the end of progressive government."</p>
<p><img src="http://reason.com/assets/mc/jtaylor/cuts4.jpg" border="0" width="559" style="border: 0px initial initial;" height="407" /></p>
<p>All things considered, Ryan&rsquo;s proposal is a definite improvement over the Deficit Commission&rsquo;s plan to increase spending by $1.6 trillion over 10 years and it&rsquo;s also a big improvement over the president&rsquo;s budget which increases spending by $1.9 trillion over the same period.</p>
<p><em style="font-style: italic;">Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a>&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University. This column <a href="http://reason.com/archives/2011/04/08/the-truth-about-spending-cuts">first appeared</a> at Reason.com.</em></p>
<p>&nbsp;</p>1011496@http://www.reason.orgFri, 08 Apr 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)Paul Ryan's Budget Plan: The Good, The Bad, &amp; The Uglyhttp://www.reason.org/news/show/paul-ryans-budget-plan-the-good-the
<p>Rep. Paul Ryan (R-Wis.) has released&nbsp;<a href="http://budget.house.gov/fy2012budget/">the official House Republican proposal</a>&nbsp;for the 2012 federal budget. It compares extremely favorably to President Barack Obama's own plan, but that is damnably faint praise.</p>
<p>From every possible perspective,&nbsp;<a href="http://www.whitehouse.gov/omb/budget/Overview/">Obama's budget</a>&nbsp;was and is a disaster waiting to happen, memorable only for reminding all Americans that you can't spell "<a href="http://www.usatoday.com/communities/theoval/post/2011/01/palin-changes-obamas-winning-the-future-phrase-/1">Winning the Future</a>" without&nbsp;<a href="http://www.urbandictionary.com/define.php?term=wtf">WTF</a>.</p>
<p>Indeed, Obama's plan for 2012 is so awful that it should make us feel lucky that he and the Democrats failed to pass a budget for the current fiscal year (the only time such a thing has happened since 1974). Obama's dream budget would mean a 2021 budget that spends $2 trillion more than we do today, increase debt held by the public from 62 percent to 77 percent of Gross Domestic Product (GDP) and maintain massive annual deficits. And that's if things go&nbsp;<a href="http://www.aolnews.com/2011/02/15/opinion-obamas-2012-budget-is-no-way-to-win-the-future/">according to his plan</a>, which they won't (built into his budget are unrealistic assumptions about the rate of economic growth, revenue collection, health care savings, and more).</p>
<p>So compared to such an exercise in recklessness, Ryan's plan is refreshingly engaged with reality. Unfortunately for taxpayers and citizens, Ryan's plan looks better when standing in the shadow of Obama's. Neither budget provides a good way forward for a country still battling the effects of recession and the non-stop, self-inflicted spending binge that began with George W. Bush and has proceeded unabated since then. Ryan's budget is indeed a positive break from past efforts by Republicans and Democrats alike, but it doesn't provide the solutions the American people deserve.</p>
<p>We made the case against&nbsp;<a href="http://www.aolnews.com/2011/02/15/opinion-obamas-2012-budget-is-no-way-to-win-the-future/">Obama's budget here</a>.&nbsp;Now, we discuss the good, the bad, and the ugly of Ryan's budget.</p>
<p><strong style="font-weight: bold;">The Good</strong></p>
<p><strong style="font-weight: bold;"><img src="http://reason.com/assets/mc/ngillespie/2011_04/ryan1.png" border="0" style="border: 0px initial initial;" /></strong></p>
<p>Ryan's budget spends considerably less money over the next decade than does Obama's. As the chart above shows, Obama expects to spend almost $6 trillion by 2021, while Ryan's plan comes in at more than a trillion dollars less, around $4.7 trillon (these amounts are in nominal dollars). Ryan's plan also calls for less revenue (taxes) than the president's and posits a significantly smaller set of annual deficits. So the amount of borrowing built into Ryan's plan is less too. That's all to the good. Lower levels of government spending and debt and taxes leaves more money in the hands of private citizens and businesses, who are far more likely to generate economic growth.</p>
<p>More important, Ryan's budget, like his 2010 "<a href="http://www.roadmap.republicans.budget.house.gov/">Road Map For America's Future</a>" (from which much in the budget is inspired), is a serious attempt to think through the implications of the past decade's wild spending spree, in which federal outlays increased by&nbsp;<a href="http://reason.com/archives/2011/02/14/the-19-percent-solution/singlepage">more than 60 percent</a>&nbsp;in real terms and debt held by the public exploded from 36 percent of GDP in 2007 to its current 62 percent level. Ryan should be commended for refusing to be passive in the face of spending trends that threaten to swamp the nation's economy. Shockingly, the "new normal" for the 21st century has been massive expansions in government spending and reach, first under Bush and now under Obama. Ryan, who voted in favor of No Child Left Behind, the Medicare Part D expansion (which gave free and reduced-price prescription drugs to seniors), TARP, and all major war funding, has certainly been part of the problem, but more recently he seems to have discovered his inner cheapskate. Better late than never.</p>
<p>Given that spending on Social Security, Medicare, and Medicaid comprises around 40 percent of annual outlays, Ryan's emphasis on reforming two of the nation's major entitlement programs is among the most attractive part of his plan. He is largely responsible for starting a much-needed discussion of changing "entitlements" from open-ended obligations on the government that get paid out regardless of their effectiveness or need. The three major entitlements - Social Security, Medicare, and Medicaid - are not just fiscally unsound, they have proven time and again to yield poor results (Social Security yields anemic&nbsp;<a href="http://reason.com/blog/2011/03/10/social-security-snoopy-snoopy">2 percent annual</a>&nbsp;returns on investment for current beneficiaries) and increase health care inflation.</p>
<p>Ryan's budget proposes block granting Medicaid, which provides health care for the poor, so that states have more flexibility in how they deliver care and control expenses. Essentially, the states would get a fixed pile of money each year that they would be free to spend as they see fit. When the money's gone, that's it. According to Cato's Chris Edwards, full block-granting of Medicaid could save around&nbsp;<a href="http://www.downsizinggovernment.org/hhs/medicaid-reforms">$95 billion a year</a>&nbsp;while delivering more effective care. Critics worry that states would simply cut care to save money, but that assumes that voters in states simply don't care about the poor or the quality of services. And it assumes the current system is actually performing well, which it is not. Most spectacularly, several studies confirm that current Medicaid recipients&nbsp;<a href="http://reason.com/archives/2010/08/06/paying-more-for-less">often have worse health-care outcomes</a>&nbsp;than similar people not in the system. Changing the funding and control structure of Medicaid is the best hope lower-income people have at this point when it comes to health care.</p>
<p><strong style="font-weight: bold;">[article continues below video]</strong></p>
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<p>For Medicare, which provides health care for senior citizens, Ryan wisely suggests getting rid of the current system, in which payments are made for every procedure performed with no cap or restraint on overall spending. Instead, Ryan proposes shifting to subsidizing premiums for seniors, who would then choose from a range of plans that best suit their needs. The phase-in of this shift would take place over the next 10 years (those 55 years and older will stay in the current system), allowing for transition. By subsidizing premiums rather than covering payments for services rendered, Ryan's plan will ostensibly make seniors and their doctors think twice before ordering up whatever test or procedure they might want at a given moment. Injecting pricing into the health care system is the only way to bring prices down and his plan should help that along. In a more combative gesture, the plan also zeroes out spending on the new health care law (<a href="http://budget.house.gov/UploadedFiles/SummaryTables.pdf">see S-3 here</a>).</p>
<p>The other good conceptual element to the Ryan budget? He calls for simplifying the income tax by reducing the number of brackets and ending tax expenditures such as the mortgage-interest deduction. And he wants to reduce the corporate income tax from its current 35 percent rate to 25 percent, a figure that would make the U.S. competitive with other developed countries. That's all good, though it's worth pointing that the budget plan, while calling for any tax reforms to be neutral in relation to revenue raised as a percentage of GDP, has essentially no specifics in it beyond the corporate tax rate.</p>
<p>Here's a video that Ryan made about the issues that he says his budget addresses:</p>
<p><strong style="font-weight: bold;">[article continues below video]</strong></p>
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<p><strong style="font-weight: bold;">The Bad</strong></p>
<p>For all of its focus on the right issues - including a debt crisis that is no longer looming but already upon us - Ryan's budget fails to deliver on spending reductions in a number of ways. For starters, it's not overly useful as a document designed to map out what the government should be spending in the next fiscal year. As noted above, it stipulates that we need a radical overhaul of tax brackets but then fails to deliver specifics on what should happen for individual income taxes. It raises the need for entitlement reform that will mostly take place after the period which it covers ends, thereby starting a debate over Medicare that it doesn't really address (other than by talking about preserving Medicare funds from "raids" on it to pay for ObamaCare). In these problems, it is clearly a condensed version of the longer Road Map rather than a stand-alone document that speaks to the budgeting process rather than a larger conversation.</p>
<p>For all the talk about bringing some basic sanity back to fiscal policy, the budget proposes spending over the next decade that averages out to 20.5 percent of GDP. That's more than 2.5 percentage points higher than the average amount of revenue raised as percentage of GDP since World War II (which has come in slighlty below 18 percent of GDP). Part of the problem is due to defense spending, which Ryan does not put on the table. He proposes spending $801 billion on "security" and the "global war on terror" in 2012 and $838 billion (in nominal dollars) in 2021. Over the same time period, non-defense discretionary spending goes from $482 billion to $422 billion. Along with entitlement spending, defense is the largest category of expenditures. When you're looking to restrain spending, you need to go where the money is, so it's simply wrong to suggest that defense spending - much of which has little to nothing to do with actually protecting American lives and property - be kept inviolate if we are in fact out of money. Defense spending has risen dramatically and not simply because of wars in Iraq and Afghanistan that even supporters acknowledge have been incompetently prosecuted. Combat operations add to the problem, but it is hardly the only driver here.</p>
<p><img src="http://upload.wikimedia.org/wikipedia/en/5/55/U.S._Defense_Spending_Trends.png" border="0" width="425" style="border: 0px initial initial;" /></p>
<p>And, needless to say, defense spending, like all contemporary spending levels, are starting from massively inflated totals. So when Ryan&nbsp;<a href="http://online.wsj.com/article/SB10001424052748703806304576242612172357504.html">brags about bringing</a>&nbsp;"spending on domestic government agencies to below 2008 levels," it's a mostly empty boast.</p>
<p>Another&nbsp;<a href="http://www.economist.com/blogs/freeexchange/2011/04/facts_and_figures">empty boast</a>&nbsp;in the plan is a report from the Heritage Foundation that says following Ryan's "Road Map" would lead to a massive increase in economic growth, and a 4 percent unemployment rate in 2015 and a 2.8 percent rate in 2021. While it's true that any gesture toward fiscal restraint would be welcomed by investors and actors in the domestic and international economy, such patently specific, ludicrous, and&nbsp;<a href="http://www.infoplease.com/ipa/A0104719.html">ahistorical rates</a>&nbsp;can't be taken seriously. Unemployment reached 4 percent in 2000, an exceptionally rare year indeed that 2015 is unlikely to repeat. The most recent year that the unemployment rate dipped below 3 percent was 1944. This is the sort of "support" which distracts from meaningful conversation.</p>
<p><strong style="font-weight: bold;">The Ugly</strong></p>
<p>The Ryan budget punts completely on the issue of Social Security reform. There's simply nothing of substance in the document, other than vague hand-waving of the historic greatness of the system and the observation that current and near-retirees will get screwed if nothing is changed. There are statements about how it would be a mistake to increase the amount of wages subject to payroll taxes and that people are living longer, but no clear proposal for how to maintain a system that no longer makes demographic sense. Yes, people are living longer and poorer people need more help in old age, so declare what the new eligibility age should be and discuss the obvious role of means-testing in possible reforms. For a bold, visionary statement that supposedly offers a real alternative to an untenable status quo, this is weak beer. Unlike when dealing with Medicaid and Medicare, Ryan doesn't suggest a similar end to entitlement status for Social Security. Why should it be exempt from the same logic? The great libertarian economist Milton Friedman once argued for a minimum guaranteed income as an alternative to all transfer payments. Certainly it makes sense to discuss Social Security in such terms.</p>
<p>Similarly, it is not simply disappointing but mind-boggling that the Ryan budget, something the Republican Party has been touting for a long time as a definitive response to President Obama's dismal and unserious offering, cannot find its way to bring annual revenue and annual outlays into balance. Ryan's longer-horizon Road Map doesn't even pretend to balance the budget until 2063, which is tantamount to giving up. We're not balanced-budget fetishists, though there are many economic benefits of having a government which lives within its means (and very few to one that doesn't). But if the federal government, after a solid decade of completely promiscuous spending, cannot reform its wicked, wicked ways, the country is in far deeper trouble than Ryan understands.</p>
<p>There are alternatives on the limited-government side.&nbsp;Sen. Rand Paul (R-Ky.) has put forth a&nbsp;<a href="http://campaignforliberty.com/materials/RandBudget.pdf">five-year balanced budget pla</a>n that forthrightly calls for the elimination of whole departments, agencies, and functions of government. Despite its boldness, Paul's plan is thoughtful. Hence, it calls for the elimination of the federal Department of Education which, since its creation during the Carter years, has failed to produce any significant increase in overall student outcomes at any level. Yet Paul also calls for continuing Pell Grants, which helps students with college tuition, at 2008 levels; we can debate the wisdom of Pell Grants (and their role in inflating tuition), but the point is that Paul's proposal is not the reckless slashing some take it to be. Similarly, when it comes to Social Security, Paul's plan calls for common-sense reforms that can only be controversial among the most-timid of analysts and politicians: raising the eligibility age, indexing for longevity, tying cost-of-living-increases to wage inflation rather than the Consumer Price Index, and establishing some form of means-testing.</p>
<p><a href="http://reason.com/archives/2011/02/14/the-19-percent-solution/singlepage">In a March Reason article</a>, we proposed a 10-year balanced budget plan that would systematically reduce outlays so that they equal the 19 percent of GDP that the Congressional Budget Office projects that the federal government will raise as revenue if the current tax system is left unchanged. That is to say, we can balance the budget over the next decade without raising taxes if we ratchet down spending from its current 25 percent of GDP to 19 percent of GDP - a figure that would still place it well above the 18.2 percent of GDP that Bill Clinton spent in his last year in office. Here's a sense of how to get from where we are to a balanced tally that would still leave us fatter than we were in 2000, when no one was complaining about a skin-flint government:</p>
<p><img src="http://reason.com/assets/mc/dpowell/2011_01/nick-vero-Fig4.jpg" border="0" width="450" style="border: 0px initial initial;" /></p>
<p>If cuts such as these are not possible, it would be better to give up any pretense that we will ever restore the barest semblance of sanity to the federal budget and get on with fiddling as Rome burns. If we're going to continue hosting a party whose bill is unpayable, we might as well enjoy ourselves.</p>
<p>Which brings us to the major flaw in Ryan's budget: He doesn't rest his reform of entitlements on a fundamental understanding that not everyone should be receiving govenment money. Even as he pushes to reform Medicare, for instance, he emphasizes continuing its universality for retirees. The two of us believe it is society's responsiblity to care for the neediest and poorest among us. But it's not society's responsiblity to take care of middle-class and wealthy individuals who have the means of doing so for themselves (as David Stockman told&nbsp;<a href="http://reason.com/archives/2011/03/21/the-triumph-of-politics-over-e">one of us recently</a>, all government benefits should be means-tested). By failing to make this distinction, Ryan sets his plan up for political failure. When his plan was scored by the Congressional Budget Office,&nbsp;<a href="http://www.cbo.gov/doc.cfm?index=12128">the CBO noted</a>&nbsp;that under his reforms most Medicare beneficiaries would have to pay more for their health care costs. That's not only mathematically correct, it's morally correct. There is simply no reason that relatively well-off seniors shouldn't pay their own way. That would allow the government to take better care of those actually in need while reducing overall tax burdens on the economy. Similarly, while we think Ryan is absolutely correct about block-granting Medicaid, at least that program is specifically geared toward helping the poor. The same cannot be said about Social Security and Medicare, which suggests reforming those programs should be the highest priority when it comes to entitlements.</p>
<p>Budget discussions are always built around a tedious discussion of what is politically feasible, politics supposedly being the art of the possible and all that. Rand Paul's five-year plan, goes this line of thinking, is as unattainable as any Soviet five-year plan because it's simply too radical, too lapidary. A 10-year plan like our "19 Percent Solution" is similarly a dream because...well, because it would actually require making minor trims over time and across all areas of spending. Defenders of the status quo will always recoil from change, even when that change simply returns us to a recent state of affairs. In this light, it's not surprising that Ryan's plan has gotten a high-five from some liberals, such as&nbsp;<em style="font-style: italic;">Slate</em>'s Jacob Weisberg, who calls it, "<a href="http://www.slate.com/id/2290509/">brave, radical, and smart</a>."</p>
<p>But as long as we're talking about the art of the possible, it's worth asking: Who would have ever thought that we'd be spending 25 percent of GDP, a figure last seen during World War II? Who would ever have thought that deficits and debt as a share of the economy would be hearkening back to days when we were locked in a twilight struggle against the Nazis and their fascist and imperialist allies? At least at the end of World War II, there was a widespread expecations that spending would be reduced. As we look to the next decade and beyond, all signs are that government spending will explode higher. The real fantasy at work in contemporary America doesn't revolve around attempts to cut spending.&nbsp;</p>
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<p>And yet Obama's completely unserious plan - offered up by a transformational change-agent who somehow couldn't even pass a budget last year despite belonging to the party that controlled both houses of Congress - is deemed worthy of serious discussion. And Rep. Paul Ryan's more-thoughtful plan to increasing total spending by 30 percent over the next decade is both lauded for "<a href="http://www.nytimes.com/2011/04/05/opinion/05brooks.html?_r=1&amp;ref=davidbrooks">grasp[ing] reality with both hands</a>" and accused of "<a href="http://www.washingtonpost.com/opinions/the-end-of-progressive-government/2011/04/01/AFQbjTXC_story.html">dismantling...key parts of government</a>."</p>
<p>As we said at the outset, there's no question that Ryan's plan is far preferable to Obama's. And there's no question that Ryan's plan can and must be the starting point of a discussion about how to get serious about reforming the way the government spends money. But in an America where taxpayers and politicians have been reluctant to fully grok that "<a href="http://reason.com/archives/2010/05/07/we-are-out-of-money">We Are Out of Money</a>" at&nbsp;<a href="http://reason.com/archives/2011/03/11/3-essential-facts-about-the-cu">every level of government</a>, Ryan's spending plan should at best represent the ceiling of what is considered worthy of discussion.</p>
<p>If, as is much more likely, it ends up being the floor from which budget negotiations spiral upwards, then our future just got a whole lot shorter.</p>
<p><em style="font-style: italic;"><a href="http://reason.com/people/veronique-de-rugy/all">Contributing Editor</a>&nbsp;Veronique de Rugy is an economist at&nbsp;<a href="http://mercatus.org/">The Mercatus Center</a>&nbsp;at George Mason University. Nick Gillespie is editor in chief of Reason.com and Reason.tv and the co-author with Matt Welch of&nbsp;<a href="http://www.amazon.com/Declaration-Independents-Libertarian-Politics-America/dp/1586489380">The Declaration of Independents: How libertarian politics can fix what's wrong with America</a>, which will be published in June. This column <a href="http://reason.com/archives/2011/04/06/paul-ryans-republican-budget-t">first appeared</a> at Reason.com.</em></p>
<p>&nbsp;</p>1011484@http://www.reason.orgWed, 06 Apr 2011 10:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Deficits and the Debthttp://www.reason.org/news/show/the-truth-about-deficits-and-the-de
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<p><em style="font-style: italic;">Editor&rsquo;s Note: Reason&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong style="font-weight: bold;">Myth 1:</strong>&nbsp;<em style="font-style: italic;">Debt and deficits are a disease that can only be cured by raising taxes.</em></p>
<p><strong style="font-weight: bold;">Fact 1:</strong>&nbsp;<em style="font-style: italic;">Debt and deficits are only a symptom. The disease is overspending. And tax increases are no cure. Besides, even if we could balance the budget by raising taxes it wouldn&rsquo;t stay balanced so long as programs like Social Security, Medicare, and Medicaid remain unreformed.</em></p>
<p>Polls&nbsp;<a href="http://thehill.com/polls/147727-the-hill-poll-voters-say-us-future-depends-on-cutting-debt">reveal</a>&nbsp;that debt and deficits have become defining issues in American politics. While these issues are indeed important and the American people are justifiably concerned about the level of debt our nation is racking up, they are only symptoms of the real problem: overspending. America is living beyond its means and is projected to continue doing so into the foreseeable future.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/deficit1.jpg" border="0" width="457" style="border: 0px initial initial;" height="319" /></p>
<p>The above chart compares tax revenues and government spending as a percentage of GDP from 1930 to the year 2084, using Congressional Budget Office (CBO)&nbsp;<a href="http://cbo.gov/doc.cfm?index=11579">projections</a>&nbsp;for the years 2011 to 2084. &nbsp;</p>
<p>As you can see,&nbsp;<a href="http://www.whitehouse.gov/omb/budget/Historicals">in the past</a>, tax revenues have averaged 15.9 percent of GDP. During recent years, revenue collection has slightly increased, averaging 18.5 percent of GDP during the 1990s, and averaging 17.5 percent of GDP during the first decade of the new millennium. Notably, the federal government&nbsp;<a href="http://reason.com/archives/2011/02/14/the-19-percent-solution">has&nbsp;<em style="font-style: italic;">never</em></a>&nbsp;been able to collect 21 percent of GDP in tax revenues. It defies reality to think that it will be able to do so now. That&rsquo;s why the CBO estimates that revenues will remain fixed at 19.3 percent of GDP into the future.</p>
<p>Yet the CBO&nbsp;<a href="http://cbo.gov/ftpdocs/121xx/doc12103/2011-03-18-APB-PreliminaryReport.pdf">anticipates</a>&nbsp;that from 2012 through 2021, the federal government will spend, on average, 23.3 percent of GDP&mdash;a higher level of spending as a percentage of GDP than the government has ever been able to collect.</p>
<p><strong style="font-weight: bold;">Myth 2:</strong>&nbsp;<em style="font-style: italic;">There is no relationship between high interest rates and deficits. And even if there was, interest rates remain at all-time lows.</em></p>
<p><strong style="font-weight: bold;">Fact 2:</strong>&nbsp;<em style="font-style: italic;">That may have been true once, but the data now shows that investors anticipate an increase in both interest rates and deficits.</em></p>
<p>For the last 20 years, economists have looked for evidence that deficits lead to higher interest rates. In 1993, for instance, North Carolina State University economist&nbsp;<a href="http://sfruc.edu.cn/jpkc/public%20finance/media/document/papers/49%20Ricardian%20Equivalence.pdf">John Seater</a>&nbsp;surveyed the literature on deficits and interest rates and concluded that the evidence is &ldquo;inconsistent with the traditional view that government debt is positively related to interest rates.&rdquo; But George Mason University economist Arnold Kling&nbsp;<a href="http://reason.org/news/show/when-do-deficits-matter">argues</a>&nbsp;that economists haven&rsquo;t seen a correlation between budget deficits and interest rates because foreign investment in U.S. assets has increased over the years, dulling the impact of fiscal policy. The real question is what happens if that investment slows or stops.</p>
<p>Moreover, deficits have reached a level that economists haven&rsquo;t really studied before. Current circumstances remind Kling of &ldquo;a guy jumping out of a building from the 10th floor, passing the third floor, and saying, &lsquo;It&rsquo;s all fine so far.&rsquo;&rdquo; Deficits do not matter up to a certain level. But at what level do we hit the ground with a resounding&nbsp;<em style="font-style: italic;">splat</em>?</p>
<p>Here is what we do know: To get deficits under control the federal government could cut spending, increase taxes, or do some combination of both. Neither of these policies is popular; hence the temptation to print money (or &ldquo;monetize the debt&rdquo;) to pay the bills. The resulting inflation would reduce the value of each dollar, and it would introduce high levels of uncertainty into the economy. Imagine what it would be like to try to calculate the net present value of your investment in an environment where you can&rsquo;t predict what your dollars will be worth tomorrow. Such circumstances mean less innovation and less entrepreneurship, and therefore less economic growth and more hardship.</p>
<p>The Federal Reserve may be reluctant to take the inflationary route. But investors know that other central banks have done so in the past and that such a scenario could happen again. In exchange for extending more loans to a federal government that has become a riskier borrower, lenders will ask for an inflation premium.</p>
<p>As the chart below illustrates, a look at the yield curve signals that investors are indeed expecting inflation and an increases in rates.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/deficit2.jpg" border="0" width="449" style="border: 0px initial initial;" height="314" /></p>
<p>The&nbsp;<a href="http://en.wikipedia.org/wiki/Yield_curve">yield curve</a>&nbsp;for U.S. Treasury securities, which reflects the functional knowledge of investors, provides a revealing look at investor expectations about the interest rates.&nbsp;In finance, the yield curve depicts the relationship between interest rates and the time to maturity of the debt. Normally, these curves slope slightly upward, reflecting investor tradeoffs between increased returns and time to maturity. However, when investors are concerned about inflation or economic uncertainty, the normally gently sloping curve can become much steeper, as investors turn away from holding securities long-term and thus drive yields higher.</p>
<p>Even now, the steepness of the yield curve for U.S. Treasury securities shows that investors expect interest rates and inflation to become higher in the future. Such expectations can lead investors to sell longer-term Treasury securities due to the predictable fact that when interest rates increase, bonds with longer maturities perform worse. In turn, that depresses the prices of those bonds and drives their yields higher.</p>
<p>Interestingly, in February China&nbsp;<a href="http://dawnwires.com/investment-news/china-russia-join-pimco-in-selling-us-treasury-this-is-fearsome-sight/">joined</a>&nbsp;PIMCO (one of the world&rsquo;s largest bond companies) in selling long-term U.S. Treasury bonds. &nbsp;</p>
<p><img src="http://reason.com/assets/mc/jtaylor/deficit3.jpg" border="0" width="434" style="border: 0px initial initial;" height="323" /></p>
<p>Understanding the relationship between maturity and interest rates sheds light on this behavior. Since 2007, China has been systematically transitioning its U.S. debt&nbsp;<a href="http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/shlhistdat.html">holdings</a>&nbsp;to short-term debt. In June 2009, the most recent month for which data is available, China&rsquo;s holdings of U.S. debt were 12 percent of its total holdings, up from 3 percent in June of 2008.</p>
<p>In future years, after more research about the current period has been done, economists may conclude that deficits did lead to higher interest rates.</p>
<p><strong style="font-weight: bold;">Myth 3:</strong>&nbsp;<em style="font-style: italic;">Debt and deficits may be a problem, but we don&rsquo;t have to fix it now.</em></p>
<p><strong style="font-weight: bold;">Fact 3:</strong>&nbsp;<em style="font-style: italic;">Debt and deficits are having an immediate negative impact on the economy.</em></p>
<p>Even in the absence of a crisis, the effects of persistent deficits remain substantial. As the government borrows, some people delay spending and investment in anticipation of future tax increases. Others will not invest in the economy or start new businesses as government borrowing consumes a greater portion of the available capital. All of this hurts the economy. Economists use the term&nbsp;<a href="http://mercatus.org/publication/long-run-we-re-all-crowded-out">&ldquo;crowding out&rdquo;</a>&nbsp;to refer to this contraction in economic activity that follows from deficit-financed spending.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/deficit4.jpg" border="0" width="432" style="border: 0px initial initial;" height="320" /></p>
<p>The chart above uses data from two&nbsp;<a href="http://cbo.gov/doc.cfm?index=11579">CBO papers</a>&nbsp;forecasting the effect on GDP per capita that crowding out may have and contrasting that with commonly-used CBO projections. The red line, which uses data from a&nbsp;<a href="http://www.fiscalcommission.gov/meetings/06-30-LTBO-Presentation-to-Fiscal-Commission.pdf">presentation</a>&nbsp;to the Fiscal Commission in June 2010, shows per capita GDP growth simply shrinking around the year 2022 due to crowding out.&nbsp;The blue line shows another&nbsp;<a href="http://cbo.gov/doc.cfm?index=11579">projection</a>&nbsp;of the impact of crowding out that starts shrinking GDP per capita in 2034. The contrast with the black line, which uses data generally referenced by scholars and government officials, is striking.</p>
<p>In other words, regardless of whether CBO&rsquo;s original or updated predictions materialize, it is very likely that the people of the United States will feel the negative impacts of high debt and deficits driven by overspending. Our country risks getting caught in a downward, potentially unmanageable spiral.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/deficit5.jpg" border="0" width="438" style="border: 0px initial initial;" height="317" /></p>
<p>The chart above shows the scale of the&nbsp;<a href="http://cbo.gov/doc.cfm?index=11579">spending cuts</a>&nbsp;that would be required to close the fiscal gap, or to stop the debt from growing as a percentage of GDP, through 2035. These estimates are conservative; they do not incorporate the feedback effects of increasing debt and deficits on the economy. Nonetheless, the longer we wait the more dramatic the required cuts will be.</p>
<p>If action is taken this year, lawmakers could close the fiscal gap through 2035 by reducing primary spending by 4.8 percent of GDP; if this action is delayed another 4 years, primary spending would have to be reduced&nbsp; by 5.7 percent of GDP.&nbsp; If lawmakers wait until 2020, the necessary cuts would grow to 7.9 percent of GDP. In other words, legislative inaction equals billions of dollars in additional spending cuts.</p>
<p><em style="font-style: italic;">Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a>&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University. This column <a href="http://reason.com/archives/2011/04/01/the-truth-about-deficits-and-t">first appeared</a> at Reason.com.</em></p>
<p>&nbsp;</p>1011467@http://www.reason.orgFri, 01 Apr 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Nuclear Powerhttp://www.reason.org/news/show/the-truth-about-nuclear-power
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<p><em style="font-style: italic;">Editor&rsquo;s Note:&nbsp;<a href="http://reason.com/people/veronique-de-rugy/all">Reason columnist</a>&nbsp;and&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong style="font-weight: bold;">Myth 1:</strong>&nbsp;<em style="font-style: italic;">Nuclear power is a cheap alternative to fossil fuels.</em></p>
<p><strong style="font-weight: bold;">Fact 1:</strong>&nbsp;<em style="font-style: italic;">It isn&rsquo;t.</em></p>
<p>As Jerry Taylor of the Cato Institute&nbsp;<a href="http://reason.com/archives/2008/10/22/nuclear-power-and-energy-indep/2">wrote in&nbsp;<em style="font-style: italic;">Reason</em>&nbsp;magazine</a>&nbsp;in 2009, &ldquo;Nuclear energy is to the Right what solar energy is to the Left: Religious devotion in practice, a wonderful technology in theory, but an economic white elephant in fact (some crossovers on both sides notwithstanding). When the day comes that the electricity from solar or nuclear power plants is worth more than the costs associated with generating it, I will be as happy as the next Greenpeace member (in the case of the former) or MIT graduate (in the case of the latter) to support either technology.&rdquo;</p>
<p>Until that time comes, producing nuclear energy remains a very costly business.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veronuke1.jpg" border="0" width="425" style="border: 0px initial initial;" height="328" /></p>
<p>The chart above uses data from a&nbsp;<a href="http://web.mit.edu/nuclearpower/pdf/nuclearpower-update2009.pdf">2009 interdisciplinary study</a>&nbsp;at the Massachusetts Institute of Technology to compare the costs of generating a kilowatt hour of electricity using nuclear, coal, and gas power. Looking at this data, the cost differential is clear&mdash;nuclear-powered energy costs 14 percent more than gas to produce a unit of electricity, and it costs 30 percent more than coal. Furthermore, according to Gilbert Metcaf&rsquo;s recent National Bureau of Economic Research paper on energy, this increased cost of nuclear energy includes a&nbsp;<a href="http://www.nber.org/chapters/c11968">baked-in taxpayer subsid</a>y of nearly 50 percent of nuclear power&rsquo;s operating costs.</p>
<p>While the nuclear industry in the United States has seen continued improvements in operating performance over time, it remains uncompetitive with coal and natural gas on the basis of price.&nbsp;This cost differential is primarily the result of high capital costs and long construction times. Indeed, building a nuclear power plant in the United States has cost, on average, three times as was originally estimated.</p>
<p>The United States Energy Information Administration&nbsp;<a href="http://www.eia.doe.gov/oiaf/aeo/electricity_generation.html">estimates</a>&nbsp;that these cost trends will continue for the near future.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veronuke2.jpg" border="0" width="419" style="border: 0px initial initial;" height="316" /></p>
<p>This chart compares the projected costs of generating electricity in the year 2016 using various sources. As you can see, nuclear power remains more expensive than other conventional forms of power.</p>
<p>As Taylor notes, this is why nuclear power has only flourished in countries where the government has intervened on its behalf.</p>
<p><strong style="font-weight: bold;">Myth 2:</strong>&nbsp;<em style="font-style: italic;">Risk is the main problem with nuclear power.</em></p>
<p><strong style="font-weight: bold;">Fact 2:</strong>&nbsp;<em style="font-style: italic;">Cost is the main problem, not risk.</em></p>
<p>Radiation is terrifying to most people. And like most things, the less you actually know about it, the more frightening it can be.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veronuke3.jpg" border="0" width="424" style="border: 0px initial initial;" height="308" /></p>
<p>Safety is certainly a critical issue, as the tragedy in Japan makes clear. However, so far the death toll from the current nuclear crisis in Japan is zero.</p>
<p>The chart above uses data compiled from various sources to compare the deaths per terawatt of energy produced.&nbsp;Deaths resulting from the production of nuclear power are&nbsp;<em style="font-style: italic;">over 4000 times less</em>&nbsp;than the rate of death resulting from the production of energy from coal.</p>
<p><a href="http://www.aapsonline.org/jpands/vol8no2/cohen.pdf">Writing</a>&nbsp;in the&nbsp;<em style="font-style: italic;">Journal of American Physicians and Surgeons</em>, Bernard Cohen, a physics professor at the University of Pittsburgh, puts the risk from nuclear power into context, comparing the relative risk of nuclear power to other activities. He used a one-in-a-million chance of increased risk of premature death as a standard. His calculations indicate that if one lived at the boundary of a nuclear power plant for five years, there would be an increased risk of premature death from nuclear radiation of one in a million. That risk would decline significantly as one moved further away from the plant.</p>
<p>Put differently, Cohen found that the risk of living next to a nuclear power plant is comparable to the risk incurred from riding 10 miles on a bicycle, riding 300 miles in an automobile, or riding 1,000 miles in an airplane.</p>
<p>In fact, Steven Chu, President Barack Obama&rsquo;s energy secretary, has made it clear he doesn&rsquo;t think nuclear power is dangerous per se. When asked to compare coal and nuclear energy in 2009,&nbsp;<a href="http://www.npr.org/blogs/thetwo-way/2009/09/energy_sec_chu_if_its_coal_vs.html">Chu responded</a>: &ldquo;I&rsquo;d rather be living near a nuclear power plant.&rdquo;</p>
<p>That being said, what happened in Japan reminds us that while nuclear doesn&rsquo;t kill people on a yearly basis, it has the potential to be very lethal under certain circumstances. However, the idea of risk-free world is unrealistic because unanticipated vulnerabilities are inevitable in any complex system. Future technologies may reduce the chance of some terrible disaster but it won&rsquo;t ever eliminate it completely. Like all other sources of energy, nuclear power entails some risk.</p>
<p><strong style="font-weight: bold;">Myth 3:</strong>&nbsp;<em style="font-style: italic;">The spread of nuclear power has stalled in the U.S. due to a hostile regulatory environment.</em></p>
<p><strong style="font-weight: bold;">Fact 3:</strong>&nbsp;<em style="font-style: italic;">Nuclear power has stalled because it is simply not profitable.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/veronuke4.jpg" border="0" width="429" style="border: 0px initial initial;" height="318" /></p>
<p>Many Americans argue that government regulations are the real reason why nuclear power is so expensive. As evidence, they point out that in France, where there is more opportunity to build nuclear power plants, nuclear power is safe and affordable.</p>
<p>It is true that France gets about&nbsp;<a href="http://www.world-nuclear.org/info/inf40.html">75 percent</a>&nbsp;of its electricity from nuclear power. It is also true that the country has avoided a large-scale disaster due to the many safety regulations it has imposed, most of which are similar to regulations enacted in the U.S.</p>
<p>However, producing nuclear energy in France is not any cheaper than it is here. The chart above shows, in U.S. dollars, the parity between the costs of generating nuclear power in the United States (which has a relatively strict regulatory regime) and France (which has a relatively loose one).&nbsp;</p>
<p>The chart presents a range of estimates of the costs of nuclear reactors in the two countries gathered by&nbsp;<a href="http://www.vermontlaw.edu/Documents/IEE/20100909_cooperStudy.pdf">Mark Cooper</a>, a senior research fellow for economic analysis at the Institute for Energy and the Environment at the Vermont Law School. As Cooper found, the ranges overlap: France&rsquo;s estimated cost of a kilowatt of power is between $4,500 and $5,000; the United States&rsquo; estimated cost for this unit of power is between $4,000 and $6,000.</p>
<p>From the start of commercial nuclear reactor construction in the mid-1960s through the 1980s, capital costs (dollars per kilowatt of capacity) for building nuclear reactors rose dramatically. Although unit costs for technology usually decrease with volume of production because of scale factors and technological learning, nuclear power has gone in the opposite direction. This exception to the rule is usually attributed to the idiosyncrasies of the nuclear regulatory environment as public opposition grew, laws were tightened, and construction times increased.</p>
<p>As a result, no new nuclear power plants have been built in the United States in 29 years. Nuclear has proven to be a poor investment, producing far more expensive electricity than originally promised.</p>
<p><strong style="font-weight: bold;">Myth 4:</strong>&nbsp;<em style="font-style: italic;">Nuclear power is the key to energy independence.</em></p>
<p><strong style="font-weight: bold;">Fact 4:</strong>&nbsp;<em style="font-style: italic;">More nuclear doesn&rsquo;t mean less oil.</em></p>
<p>On last Sunday&rsquo;s&nbsp;<em style="font-style: italic;">Meet the Press</em>, Sen. Charles Schumer (D-NY)&nbsp;<a href="http://www.nbcumv.com/mediavillage/networks/nbcnews/meetthepress/pressreleases?pr=contents/press-releases/2011/03/13/meetthepresscli1300036741343.xml">cited</a>&nbsp;America&rsquo;s need to get off of foreign oil as a strong reason for pursuing nuclear power.</p>
<p>Setting aside the misguided goal of so-called energy independence, Schumer is still wrong. Oil is primarily used in vehicles and in industrial production. Nuclear power is primarily used for electricity.</p>
<p>As the chart below illustrates,&nbsp;<a href="http://www.eia.doe.gov/oiaf/aeo/pdf/0383(2010).pdf">data</a>&nbsp;from the United States Energy Information Administration shows that the vast majority of our electricity comes from non-oil sources.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veronuke5.jpg" border="0" width="477" style="border: 0px initial initial;" height="349" /></p>
<p>Interestingly, according Michael Levi, a senior fellow and director of the program on energy security and climate change at the Council on Foreign Relations, it wasn&rsquo;t always the case. &ldquo;During the heyday of nuclear power, the early 1970s (45 plants broke ground between 1970 and 1975),&rdquo; Levi writes, &ldquo;oil was a big electricity source, and boosting nuclear power was a real way to squeeze petroleum out of the economy. Alas, we&rsquo;ve already replaced pretty much all the petroleum in the power sector; the opportunity to substitute oil with nuclear power is gone.&rdquo;</p>
<p>Perhaps more importantly,&nbsp;<a href="http://lugar.senate.gov/energy/graphs/sector.html">less than 1 percent</a>&nbsp;of the oil used in the United States today goes to generate electricity while 70 percent&nbsp;is consumed by the transportation sector, with roughly 30 percent of oil being used by the residential and industrial sectors.</p>
<p>The bottom line is that more nuclear power would mean less coal, less natural gas, less hydroelectric power, and less wind energy. But more nuclear won&rsquo;t mean less oil.</p>
<p>Am I against nuclear power? It certainly looks like nuclear can never be a sustainable source of energy because it is just too expensive. And while it is a safe source of energy overall, there are tremendous risks in those instances where something goes disastrously wrong. The probability of such a dire scenario may be low, but the need to build-in protections against it will always raise the cost of producing nuclear power.</p>
<p>But more importantly, what I am against is the government deciding that nuclear power must be encouraged and then subsidizing the industry. On that point, I leave the last word to&nbsp;<em style="font-style: italic;">Reason</em>&nbsp;Science Correspondent Ronald Bailey.</p>
<p>&ldquo;The main problem with energy supply systems is that for the last 100 years, governments have insisted on meddling with them, using subsidies, setting rates, and picking technologies,&rdquo;&nbsp;<a href="http://reason.com/archives/2011/03/15/nuclear-disaster-in-japan">Bailey observes</a>. &ldquo;Consequently, entrepreneurs, consumers, and especially policymakers have no idea which power supply technologies actually provide the best balance between cost-effectiveness and safety. In any case, let&rsquo;s hope that the current nuclear disaster will not substantially add to the terrible woes the Japanese must bear as a result of nature&rsquo;s fickle cruelty.&rdquo;</p>
<p><em style="font-style: italic;">Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a>&nbsp;is a senior research fellow at the&nbsp;<a href="http://mercatus.org/">Mercatus Center</a>&nbsp;at George Mason University. This column <a href="http://reason.com/archives/2011/03/25/the-truth-about-nuclear-power">first appeared</a> at Reason.com.</em></p>
<p>&nbsp;</p>1011433@http://www.reason.orgFri, 25 Mar 2011 12:00:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Hedge Funds and the Financial Crisishttp://www.reason.org/news/show/the-truth-about-hedge-funds-and-the
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<p><em>Editor&rsquo;s Note: Reason columnist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Hedge funds are highly leveraged.</em></p>
<p><strong>Fact 1:</strong> <em>The market exposure of most hedge funds is less than twice the percentage of assets under management.</em> &nbsp;</p>
<p>Contrary to commonly-held belief, highly-leveraged hedge funds are the exception rather than the rule. Hedge funds use short sales and derivatives to manage risk and reduce losses when the market is performing poorly. In addition, hedge funds often borrow funds or use other forms of leverage to magnify gains.</p>
<p>Furthermore, hedge funds take no part in the process of underwriting new securities. Nor do they serve as brokers or dealers of securities and derivatives. These funds have a single line of business&mdash;asset management&mdash;and they typically use relatively small amounts of leverage to finance and profit from their investment activities.</p>
<p>A <a href="http://www.oecd.org/dataoecd/36/62/40972327.pdf">2007 study of hedge fund leverage</a> by Adrian Blundell-Wignall,&nbsp; a deputy director of the Organization for Economic Co-operation and Development (OECD), which included leverage from borrowed funds and implicit leverage from derivatives, estimated that average hedge fund leverage was 3.9-to-1 (which means that for every $3.9 in hedge fund assets, $1 was equity and the rest was borrowed (or the economic equivalent of borrowing was achieved by using derivatives), with the bulk of the leverage coming from derivatives. In 2008, the International Monetary Fund (IMF) <a href="http://www.imf.org/external/pubs/ft/gfsr/2008/02/pdf/text.pdf"> estimated</a> that average global hedge fund leverage from borrowed funds had a ratio of 1.4-to-1.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohedge1.jpg" border="0" width="371" height="265" /></p>
<p>The chart above is based on data from the McKinsey Global Institute; note that it measures leverage in a slightly different way than the OECD does (gross leverage here is assets plus liabilities divided by assets) but the overall outcome is quite similar. As you can see, even at its peak, total leverage in the hedge fund industry was not more that 3.5 times the level of assets under management&mdash;far below the leverage ratio of banks.</p>
<p>For context, consider that banks are typically leveraged at least 10-to-1 and investment banks are usually leveraged at least 20-to-1. In the case of investment banks, this means that for every dollar actually held by the investment bank, it had borrowed between $20 and $30.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohedge2.jpg" border="0" width="446" height="301" /></p>
<p>More interestingly, as New York Law School professor Houman Shadab notes in his article &ldquo;<a href="http://mercatus.org/sites/default/files/publication/RSP_MOP34_Hedge_Funds_and_the_Financial_Crisis.pdf">Hedge Funds and the Financial Crisis</a>,&rdquo; the contrast between the levels of leverage in these different components of the financial sector became even more pronounced in the lead-up to the financial crisis. For example, banking sector leverage usually ranged from 12-to-1 to 17-to-1 while major U.S. investment bank leverage became as high as 33-to-1 in recent years.</p>
<p><strong>Myth 2:</strong> <em>The hedge fund industry&rsquo;s tendency to take excessive risks, combined with a lack of regulation, was an important cause of the financial crisis.</em></p>
<p><strong>Fact 2:</strong> <em>Not only did hedge funds not precipitate the financial crisis, they did nothing to exacerbate it. If anything, hedge funds have helped the economy to recover more quickly.</em></p>
<p>It is a fact that hedge funds are not as heavily regulated as other financial institutions. Also, they are not required to register with investment authorities or report on their activities. As a result, it is often alleged that hedge funds played a role in the emergence of the credit crisis, contributing to volatility through short-selling and by selling shares as a result of de-leveraging and redemptions.</p>
<p>The data, however, does not support such theories. While hedge funds have often seen greater payoffs than the larger financial industry, they have done so while taking fewer risks. &nbsp;</p>
<p>McKinsey Global Institute research <a href="http://www.mckinsey.com/mgi/publications/the_new_power_brokers_financial_crisis/"> shows</a>, for instance, that a significant portion of hedge funds have delivered higher and less volatile returns than investments in public equities and bonds over time, including during the financial crisis.</p>
<p>McKinsey also <a href="http://www.mckinsey.com/mgi/publications/the_new_power_brokers_financial_crisis/"> found</a> that since 1990 investors in hedge funds have earned higher returns than investors whose portfolios contain only equities and bonds. Between 1990 and 2008, an index of hedge funds outperformed a range of blended portfolios of U.S. bonds and equities. The hedge fund index produced 12 percent average annual returns over the period, compared with 7.8 percent for a portfolio of only equities and 7.2 percent for a portfolio of only bonds.</p>
<p>More importantly, hedge funds fared relatively better during the financial crisis than other firms in the industry. In 2008, as losses from the U.S. mortgage market turned into an international financial crisis, global equities dropped 42 percent. Yet hedge funds suffered worldwide losses of just 27 percent.</p>
<p>As the following chart from Shadab&rsquo;s &ldquo;Hedge Funds and the Financial Crisis&rdquo; shows, hedge funds have systematically outperformed the stock market in downturns.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohedge3.jpg" border="0" width="519" height="295" /></p>
<p>Why? These outcomes are attributable in large part to the legal regime under which they occur. First, federal law enables hedge funds to pursue innovative investment strategies through leverage, short sales, and derivatives. Second, contract law and the hedge fund structure provides fund managers with incentives to innovate while maintaining a relatively healthy balance between risk taking and risk management.</p>
<p>Take the hedge fund compensation scheme. Hedge fund managers are compensated by charging a management fee based upon the size of the fund (typically 1 to 2 percent for hedge funds) but they also charge an annual performance-based fee, typically 20 percent of profits. In addition, they frequently invest their own money in the funds they manage.</p>
<p>This compensation structure generally leads hedge funds to be more prudent in risk-taking than other financial companies. Most hedge fund managers seek to maximize asset size and put much more emphasis on low volatility at the cost of returns so that they can optimize assets under management and asset management fees.&nbsp;</p>
<p>Basically, it is a myth that hedge fund managers are risk takers who seek to maximize&nbsp;returns.&nbsp; &nbsp;</p>
<p>As Shadab notes, &ldquo;a general lesson from the law and economics of hedge funds is that when a legal regime permits financial intermediaries to be flexible in their investment strategies and aligns the incentives of investors and innovators through performance fees and co-investment by managers, financial innovation is likely to complement investor protection without wide-ranging regulation.&rdquo;</p>
<p><strong>Myth 3:</strong> <em>Most hedge fund managers are billionaires.</em></p>
<p><strong>Fact 3:</strong> <em>Who cares? But if you must know, the average hedge fund manager&rsquo;s yearly earnings are $336,000.</em></p>
<p>We hear all the time that hedge fund managers are billionaires. This belief likely stems from a <a href="http://www.nytimes.com/2010/04/01/business/01hedge.html">highly-publicized survey</a> which revealed that in 2009, the 25 highest-paid hedge fund managers earned a collective $25.3 billion, beating the old 2007 high by a wide margin. Yet this number is not representative of the larger hedge fund industry.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verohedge4.jpg" border="0" width="485" height="287" /></p>
<p>The chart above uses data collected from a series of confidential surveys of fund managers and employees across a variety of firms, large and small. Average compensation of hedge fund managers in 2009 was around $336,000 with roughly 50 percent of this compensation paid as a bonus. Importantly, since compensation is so closely tied to performance, managers have the incentive to maximize performance and take judicious risks. In other words, they have some skin in the game.</p>
<p>While much has been made of super-rich hedge fund managers such as George Soros and David Tepper, compensation actually varies widely within the profession. On the low end, earnings fall within the $50,000 range; on the high-end, certain well-publicized partners, principals, and fund managers make over a million dollars annually. The majority of hedge fund managers surveyed in 2008 <a href="http://www.jobsearchdigest.com/hedge_fund_jobs/career_advice/hedge_fund_compensation_2008"> reported</a> compensation in the $100,000 to $300,000 range. Less than 2 percent of hedge fund managers report earnings of over a million dollars.</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> is a senior research fellow at the Mercatus Center at George Mason University. This column <a href="http://reason.com/archives/2011/03/18/the-truth-about-hedge-funds-an">first appeared</a> at Reason.com.<br /></em></p>1011390@http://www.reason.orgFri, 18 Mar 2011 16:30:00 EDTvdereugy@gmu.edu (Veronique de Rugy)The Truth About the State Pension Crisishttp://www.reason.org/news/show/the-truth-about-the-state-pension-c
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<p><em>Editor&rsquo;s Note: Reason columnist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong>Myth 1:</strong> <em>Unfunded state pensions do not represent an immediate threat and are therefore not in crisis.</em></p>
<p><strong>Fact 1:</strong> <em>In the best case scenario, some state pension funds will run out as soon as 2017. And the longer the states wait to fully fund their pensions, the more drastic the financial consequences will be.</em></p>
<p>The fact that state pensions only represent a small share of state budgets doesn&rsquo;t mean that they aren&rsquo;t in crisis. Take the case of New Jersey. According to <a href="http://kelloggfinance.wordpress.com/2010/03/22/the-day-of-reckoning-for-state-pension-plans/"> Joshua Rauh</a>, professor of finance at Northwestern University, under the best case scenario, New Jersey&rsquo;s pension funds (there are 5 of them) are scheduled to run out as soon as 2017. Once those state pension plans run out of money, pension payments will have to come out of the state&rsquo;s general fund revenues&mdash;that is, out of the pockets of state taxpayers.</p>
<p>Furthermore, there is reason to believe these estimates are too conservative. When private-sector accounting methods are used to show the true market value of state pension liabilities, the situation becomes even more critical than it initially appears. &nbsp;</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veropension1.jpg" border="0" width="428" height="326" /></p>
<p>According to <a href="http://mercatus.org/sites/default/files/publication/WP1031-%20NJ%20Pensions.pdf"> Andrew Biggs of the American Enterprise Institute and my Mercatus Center colleague Eileen Norcross</a>, the state of New Jersey reports that its pension systems are underfunded by $44.7 billion. Yet when those pension plan liabilities are calculated in a manner consistent with private-sector accounting requirements&mdash;methods that economists almost universally agree to be more appropriate&mdash;New Jersey's unfunded benefit obligation rises to $173.9 billion.</p>
<p>In other words, New Jersey has made a $173 billion promise without any idea of how it will pay for it. I would say that&rsquo;s a crisis.</p>
<p>Plus, this is serious money. As Biggs and Norcross note,</p>
<blockquote>
<p>This amount is equivalent to 44 percent of the state's current GDP and 328 percent of its current explicit government debt. This calculation applies a discount rate of 3.5 percent (the yield on Treasury bonds with a maturity of 15 years) to reflect the nearly risk&#8208;free nature of accrued benefits for workers. It is estimated if state pension assets average a return of 8 percent, New Jersey will run out of funds to meet its pension obligations in 2019. If asset returns are lower than 8 percent, they will run out of funds sooner.</p>
</blockquote>
<p>This has real implications. State actuaries estimate that under certain assumptions, New Jersey&rsquo;s pension plans will run out of enough assets to make benefit payments beginning in 2013.</p>
<p>The irony is that New Jersey, like other states, has put itself in a financial binder even before the pension crisis really hits. That says a lot about the state&rsquo;s future ability to address the problem.</p>
<p><strong>Myth 2:</strong> <em>State debt accurately reflects state liabilities. And state default is not a concern because the federal government will bail the states out before they reach that point.</em></p>
<p><strong>Fact 2:</strong> <em>Many government pension liabilities are kept off the books, so most states and cities underestimate their actual debt.</em></p>
<p>Consider Connecticut. Bonds are only a small part of its total debt. Like many other states, Connecticut also owes to its pensions and retiree health care funds, which are not clearly disclosed, and which will cost even more in the long run.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veropension2.jpg" border="0" width="415" height="324" /></p>
<p>Northwestern's Joshua Rauh and Robert Novy-Marx, an assistant professor of finance at the University of Rochester, have added Connecticut&rsquo;s unfunded liability to the state&rsquo;s debt. As you can see in the chart above, the state&rsquo;s reported debt is roughly $23 billion. The official estimated value of its unfunded pension liabilities is $48.4 billion. That&rsquo;s $71.4 billion. On top of that amount we should add another $28.2 billion in underestimated liabilities due to poor accounting standards. Now you have a total state debt of almost $100 billion.</p>
<p>Would the federal government really have the ability to bail out 50 states whose individual debt often exceeds $100 billion? That would cost roughly $5 trillion. And while all of that money wouldn&rsquo;t be paid out at once, it is still unrealistic for the states to count on a federal bailout.</p>
<p><strong>Myth 3:</strong> <em>State and local workers are not overpaid. And even if they are, changing their compensation won&rsquo;t make a difference.</em></p>
<p><strong>Fact 3:</strong> <em>While this is a complex issue, the total compensation package for state workers does tend to exceed that of their private-sector counterparts.</em></p>
<p>Take the case of Ohio.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veropension3.jpg" border="0" width="425" height="324" /></p>
<p>The Buckeye Institute for Policy Solutions has an interesting report out called &ldquo;<a href="http://buckeyeinstitute.org/uploads/files/The%20Grand%20Bargain%20Is%20Dead%281%29.pdf">The Grand Bargain is Dead</a>.&rdquo; As we see in this example from Ohio, compensation costs for state and local employees begins at a higher level than that of their private-sector counterparts and continues to diverge throughout the employees&rsquo; careers. According to the Buckeye Institute, for 26 careers in state and local government paying around the median wage rate, government employees were consistently and significantly paid above the corresponding private-sector wage rate.</p>
<p>Ohio has an on-the-book $8 billion budget gap. The data shows that in the Buckeye state, where almost one new public-sector job was added to the economy for each private-sector job from 1990 to 2010, realigning state worker compensation packages to match those of their private-sector peers would save taxpayers over $2.1 billion in the next two years (or 28 percent of this year&rsquo;s $8 billion deficit).</p>
<p>It is true that comparing compensation is a tricky business. While taking a closer look at the differences between public and private-sector employees explains some of the compensation differential, it is not great enough to explain the difference in wages between comparable public and private employees.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/veropension4.jpg" border="0" width="425" height="322" /></p>
<p>This chart <a href="http://www.nytimes.com/interactive/2011/03/06/us/public-private-employees.html?scp=1&amp;sq=public&amp;st=cse"> from <em>The New York Times</em></a> shows that there are 12 percent more white-collar workers in local government than there are in private employment and 19 percent more white-collar workers at the state level. Some argue that this is the reason for the difference in compensation. It&rsquo;s the diplomas stupid! Maybe, but all the diplomas in the world can&rsquo;t explain the 221 percent difference in lifetime employment costs witnessed by workers in Ohio.</p>
<p><strong>Myth 4:</strong> <em>The financial crisis, which caused a depreciation of pension assets, is the real culprit behind pension underfunding.</em></p>
<p><strong>Fact 4:</strong> <em>While the recession dealt a severe blow to state pensions, the problem of pension underfunding dates back to the early 2000s. Many states had already failed to cover the cost of promised benefits even before they felt the full weight of the Great Recession.</em></p>
<p><img src="http://reason.com/assets/mc/jtaylor/veropension5.jpg" border="0" width="336" height="352" /></p>
<p>The problem started long before the recession. A 2010 Pew study called &ldquo;<a href="http://downloads.pewcenteronthestates.org/The_Trillion_Dollar_Gap_final.pdf">The Trillion Dollar Gap</a>,&rdquo; found that in 2000, slightly more than half of the states had fully funded pension systems.&nbsp; By 2006, that number had shrunk to six states. By 2008, only four states&mdash;Florida, New York, Washington and Wisconsin&mdash;could make that claim. The chart above, taken from the Pew study, illustrates this point.</p>
<p>Here&rsquo;s the bottom line: We can argue endlessly over when the pension plans will run out of cash, or what the true value of the unfunded liabilities is. We can even debate what the true meaning of being broke. But there is one issue where there is no room for debate. Once the pension plans run out of money, the payments will have to come out of general funds, meaning out of the pockets of taxpayers. If the states want to avoid this, they must push through reforms as soon as possible. A good first step would be to switch to accounting methods that show the true market value of their liabilities. Once those methods are in place, lawmakers should consider moving away from defined benefit pensions.</p>
<p><em>Contributing Editor <a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a> is a senior research fellow at the Mercatus Center at George Mason University. This column <a href="http://reason.com/archives/2011/03/11/the-truth-about-the-state-pens">first appeared</a> at Reason.com.<br /></em></p>1011357@http://www.reason.orgFri, 11 Mar 2011 12:00:00 ESTvdereugy@gmu.edu (Veronique de Rugy)The State Pension Time Bombhttp://www.reason.org/news/show/the-state-pension-time-bomb
<p>For decades state officials have encouraged adults to believe in the financial equivalent of the Tooth Fairy: that state pensions can yield high returns while being risk-free. Now taxpayers are in for a serious toothache.</p>
<p>Nearly every state offers defined-benefit pension plans for public employees. Financed through a mix of employee and employer contributions along with the investment returns on pension funds, a defined-benefit plan represents a contractual obligation to dole out a set amount in annual payments for as long as the recipient lives, regardless of whether there are sufficient assets in the fund at the time of the employee&rsquo;s retirement.</p>
<p>One would think this obligation to pay no matter what would have led states to invest conservatively and plan ahead. Instead, they have been following accounting rules that pretty much guarantee the funds will be unsustainable.</p>
<p>First, by law, states are not required to pony up regular contributions to pension systems. Lawmakers generally jump on any opportunity to be fiscally irresponsible, so many states have deferred pension payments and used their share of the contribution to increase spending in other areas.</p>
<p>Second, government accounting standards systematically underestimate fund liabilities, which in turn encourages pension deferrals. Eileen Norcross, my colleague at the Mercatus Center at George Mason University, argued in a December 2010 paper that the difference between government and private-sector accounting rules is at the root of the unfunded liability crisis.</p>
<p>For accounting purposes, private pension plans use the market value of their liabilities. This rule requires future liabilities to be discounted at an interest rate that matches the risks associated with the assets; the resulting value represents the amount a private insurance company would demand to issue annuities covering all the benefits owed by a given plan. By contrast, states calculate the value of pension liabilities based on the returns they expect from investing pension assets. And on average, the states assume an unrealistically high 8 percent annual return on pension investments while the actual rate should be closer to the yield of 15-year treasury bonds. Here is why that&rsquo;s so problematic.</p>
<p>Pension funds need to assume a certain rate of return on their current assets in order to gauge whether or not the assets held today will be enough to pay future benefits. Obviously, the assumed interest rate or rate of return has a major impact on whether a pension plan is adequately funded. Most pension plans would rather play it conservatively and assume a lower rate of return, so that they ensure that the assets they have today will be enough to cover tomorrow&rsquo;s promised benefits. But the states would rather put less money up front today, so they&rsquo;re pinning all their hopes of being able to pay benefits tomorrow on an 8.5 percent annual growth rate. If that 8.5 percent growth rate doesn&rsquo;t come to fruition, either tomorrow&rsquo;s beneficiaries will see a cut in their benefits or taxpayers will be asked to pick up the tab. It would be much more prudent to assume an adequate risk-adjusted rate of return closer to the rate offered on 15-year Treasury bonds&mdash;3.5 percent, say&mdash;and fund their plan accordingly.</p>
<p><img src="http://reason.com/assets/mc/dpowell/2011_02/derugy-figure1.jpg" border="0" width="400" style="float: right;" height="312" />An unrealistically high discount rate also means that states are highly discounting the likelihood of future payments. In other words, the states are essentially stating that there&rsquo;s a low probability that they&rsquo;ll have to pay their pensioners. That is silly.</p>
<p>State officials not only failed to set aside sufficient money to fund future benefits, but they also illogically assumed that the riskier the investment, the better funded the plan would be. Illinois, for example, borrowed $10 billion in 2003 and used the money to invest in its pension funds. After the recession sent its investment returns below its expected target in 2010,&nbsp;<em style="font-style: italic;">The New York Times</em>&nbsp;reported in December, Illinois sold an additional $3.5 billion worth of pension bonds. This year alone the state is planning to borrow $3.7 billion more for to repay those pension bonds, with interest.</p>
<p>How big are the shortfalls? State officials estimated their plans&rsquo; unfunded liabilities at $452 billion, with total liabilities of $2.8 trillion. But when economist Andrew Biggs of the American Enterprise Institute calculated the figure with the methods used by private-sector pensions, he found that total liabilities amount to over $5 trillion, with the unfunded liability at $3 trillion. (See Figure 1.)</p>
<p>Since much of government pension liabilities is off the books, most states and cities underestimate their actual debt. In Figure 2, Joshua D. Rauh, an associate professor of finance at Northwestern University, and Robert Novy-Marx, an assistant professor of finance at the University of Rochester, add Connecticut&rsquo;s unfunded liability to the state&rsquo;s debt. As you can see, the state&rsquo;s reported debt is roughly $23 billion. The estimated value of its unfunded pension liabilities is $48.4 billion. To that amount we should add another $28.2 billion in underestimated liabilities due to poor accounting standards.</p>
<p><img src="http://reason.com/assets/mc/dpowell/2011_02/derugy-figure2.jpg" border="0" width="550" style="border: 0px initial initial;" height="355" /></p>
<p>While all states&rsquo; pension plans are in bad shape, some are worse than others. Figure 3 shows the first 10 states scheduled to run out of cash.</p>
<p>Once the pension plans run out of money, the payments will have to come out of general funds, meaning taxpayers&rsquo; pockets. If states want to avert that, they need to push through reforms as soon as possible. A first step would be to switch to accounting methods that show the true market value of their liabilities. Once these methods are in place, lawmakers could consider moving away from defined benefit pensions. Otherwise, taxpayers will discover too late that the Tooth Fairy of their dreams is actually the Wicked Witch of the West.&nbsp;</p>
<p><img src="http://reason.com/assets/mc/dpowell/2011_02/derugy-figure3.jpg" border="0" width="400" style="border: 0px initial initial;" height="507" /></p>
<p><em style="font-style: italic;">Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a>&nbsp;(vderugy&#64;gmu.edu) is a senior research fellow at the Mercatus Center at George Mason University. This column <a href="http://reason.com/archives/2011/03/08/the-state-pension-time-bomb">first appeared</a> at Reason.com.</em></p>
<p>&nbsp;</p>1011337@http://www.reason.orgTue, 08 Mar 2011 12:00:00 ESTvdereugy@gmu.edu (Veronique de Rugy)The Truth About Fannie and Freddieâ??s Role in the Housing Crisishttp://www.reason.org/news/show/the-truth-about-fannie-and-freddies
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<p><em style="font-style: italic;">Editor&rsquo;s Note: Reason columnist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.</em></p>
<p><strong style="font-weight: bold;">Myth 1:</strong>&nbsp;<em style="font-style: italic;">The government-sponsored housing finance companies Fannie Mae and Freddie Mac had nothing to do with the housing crisis. They were simply innocent bystanders caught in the crossfire.&nbsp;Economist and</em>&nbsp;New York Times&nbsp;<em style="font-style: italic;">columnist Paul Krugman, for instance,&nbsp;<a href="http://krugman.blogs.nytimes.com/2008/11/17/fannie-freddie-data/">has argued</a>&nbsp;that Fannie and Freddie&rsquo;s role in the housing market was insignificant between 2004 and 2006 because &ldquo;they pulled back sharply after 2003, just when housing really got crazy.&rdquo;&nbsp;<a href="http://www.nytimes.com/2008/07/14/opinion/14krugman.html?_r=1">According</a>&nbsp;to Krugman, Fannie and Freddie &ldquo;largely faded from the scene during the height of the housing bubble.&rdquo;</em></p>
<p><strong style="font-weight: bold;">Fact 1:</strong>&nbsp;<em style="font-style: italic;">Fannie and Freddie contributed to the housing crisis by making it easier for more people to take out loans for houses they could not afford. Beginning in 2000, Fannie and Freddie took on loans with low FICO scores, loans with low down payments, and loans with little or no documentation.</em></p>
<p>The federal government&rsquo;s role in the housing market goes back at least to 1938, but that role changed fundamentally in the 1990s when the government made a push to increase homeownership in the United States. At that time, the federal government pursued several policies that were meant to encourage banks to lend money to lower income earners and to give incentives to low income earners to buy houses. The result, as we now know, was a gigantic amount of subprime mortgages at a time when house prices were starting to go down.</p>
<p>In 2010, Edward Pinto, a resident fellow at the American Enterprise Institute who has served as chief credit officer at Fannie Mae,&nbsp;<a href="http://www.aei.org/paper/100174">issued a memorandum</a>&nbsp;on the number of subprime and other high-risk mortgages in the financial system immediately before the financial crisis. In that memorandum, Pinto recorded that he had found over 25 million subprime mortgages (his later work showed that there were approximately 27 million).&nbsp;Since there are about 55 million total mortgages in the United States, it means that as the financial crisis began,&nbsp;<em style="font-style: italic;">half</em>&nbsp;of all U.S. mortgages were of inferior quality and liable to default when housing prices stopped rising, as you can see in the chart below.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verofannie1.jpg" border="0" width="432" style="border: 0px initial initial;" height="315" /></p>
<p>Freddie and Fannie were active players in this market.&nbsp;</p>
<p>For instance, as George Mason University economist Russ Roberts explains in his paper &ldquo;<a href="http://mercatus.org/publication/gambling-other-peoples-money">Gambling with Other People&rsquo;s Money</a>&rdquo;:</p>
<blockquote>
<p>Fannie and Freddie bought 25.2% of the record $272.81 billion in subprime MBS [mortgage-backed securities] sold in the first half of 2006, according to Inside Mortgage Finance Publications, a Bethesda, MD-based publisher that covers the home loan industry.</p>
</blockquote>
<blockquote>
<p>In 2005, Fannie and Freddie purchased 35.3% of all subprime MBS, the publication estimated. The year before, the two purchased almost 44% of all subprime MBS sold.</p>
</blockquote>
<p>In addition, lawmakers in both parties enacted policies directed at increasing home ownership rates, resulting in lower mortgage underwriting standards for Fannie and Freddie. Roberts notes that from 2000 on, Fannie and Freddie bought loans with low FICO scores, loans with very low down payments, and loans with little or no documentation. Contrary to Paul Krugman&rsquo;s assertions, Fannie and Freddie did not &ldquo;fade away&rdquo; or &ldquo;pull back sharply&rdquo; between 2004 and 2006.</p>
<p>As the following chart from Roberts&rsquo; study shows, during that same time Government Sponsored Enterprises (GSEs) bought near-record numbers of mortgages, including an ever-growing number of mortgages with low down payments.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verofannie2.jpg" border="0" width="499" style="border: 0px initial initial;" height="329" /></p>
<p>Moreover, as the chart below shows, while private players bought many more subprime loans than Freddie and Fannie, GSEs purchased hundreds of billions of dollars worth of subprime mortgage-backed securities (MBS) from private issuers, holding these securities as investments.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verofannie3.jpg" border="0" width="500" style="border: 0px initial initial;" height="392" /></p>
<p>The bottom line is that while Fannie and Freddie weren&rsquo;t the only factor leading to the financial crisis, they played an important role in pushing up the demand for housing at the low end of the market, especially between 1998 and 2003. That in turn made subprime loans increasingly attractive to other financial institutions as housing prices rose steadily.</p>
<p><strong style="font-weight: bold;">Myth 2:</strong>&nbsp;<em style="font-style: italic;">Fannie and Freddie&rsquo;s role in the housing market increased homeownership, especially for first-time buyers and lower income earners.</em>&nbsp;&nbsp;</p>
<p><strong style="font-weight: bold;">Fact 2:</strong>&nbsp;<em style="font-style: italic;">The small increase in homeownership rates were temporary and artificial, driven by unsustainable incentives. In the best case scenario, Fannie and Freddie may have increased the homeownership rate from 63 percent to 69 percent, but the rate has now fallen back to 66 percent. Moreover, Fannie and Freddie did not make housing more affordable and even priced many first-time buyers out of the market.</em></p>
<p>When it was created in 1938 Fannie Mae&rsquo;s mission was to stabilize the Great Depression&rsquo;s battered home mortgage market by focusing on first-time homebuyers.</p>
<p>From 1940 to 1965, homeownership expanded from 44 to 63 percent. It&rsquo;s debatable whether this increase in homeownership was good, bad, or even if it was the product of Fannie&rsquo;s actions at all. &nbsp;</p>
<p>However, it is interesting to observe the role that government support has played in Fannie and Freddie&rsquo;s actions. While Fannie and Freddie enjoy access to capital from the public equity market, they also benefit from exclusive privileges including a line of credit with the government, no oversight by the Securities and Exchange Commission, and a government guarantee that gives these entities a lower cost of funds than their private sector rivals.</p>
<p>As business journalist Bill Bonner&nbsp;<a href="http://www.csmonitor.com/Business/The-Daily-Reckoning/2010/0621/Fannie-and-Freddie-Homeownership-at-whose-expense">explains</a>&nbsp;in&nbsp;<em style="font-style: italic;">The Christian Science Monitor</em>:</p>
<blockquote>
<p>Armed with these advantages, GSEs increased their book of business from $13 billion in 1965 to $1 trillion by 1990 and $3.4 trillion in 2003. Once the great real estate bubble had concluded by year-end 2007, Freddie and Fannie combined had purchased $4.9 trillion of mortgages, repackaging 70 percent of these into guaranteed securities for the secondary market.</p>
</blockquote>
<blockquote>
<p>This (along with Ginnie Mae) gave the GSEs roughly half of the $11 trillion mortgage market, but their share of new originations has become near dominant.</p>
</blockquote>
<blockquote>
<p>Many sources peg this at 70 percent, but an interesting take from TIME magazine business and economics columnist Justin Fox takes into account the impact of refinancing into GSE-backed loans. Juxtaposing GSE total volume ($ 539 billion) against new originations ($313 billion), GSE market share was 172 percent for the first quarter of 2008.</p>
</blockquote>
<p>As the chart below shows, while homeownership topped out at 69 percent in 2004 and stood at 66 percent in 2010, it hasn&rsquo;t really increased from its 63 percent level nearly 50 years ago when the government restructured the agencies to promote their growth.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verofannie4.jpg" border="0" width="447" style="border: 0px initial initial;" height="333" /></p>
<p>Unfortunately, we also know that many of the government&rsquo;s policies ended up increasing housing prices dramatically by increasing demand, thus pricing many first-time buyers out of the market.</p>
<p><strong style="font-weight: bold;">Myth 3:</strong>&nbsp;<em style="font-style: italic;">Fannie and Freddie are essential for maintaining a working mortgage market. Without them, interest rates will increase and homeownership will plummet as more people are priced out of the housing market.</em></p>
<p><strong style="font-weight: bold;">Fact 3:</strong>&nbsp;<em style="font-style: italic;">Interest rates are likely to go up. Yet it is not clear what impact this will have on homeownership rates. In the 1980s, interest rates on the average 30-year mortgage were significantly higher, yet homeownership rates were almost the same as they are today. Besides, the alternative to homeownership is not living on the street.</em></p>
<p>President Barack Obama has proposed allowing Fannie and Freddie to slowly fade away. This would certainly have consequences. For one thing, without federal backing, a 30-year mortgage with a 5 percent interest rate is unlikely to be replicated by any bank. In addition to charging higher interest rates, banks would also likely require a larger down payment.</p>
<p>However, it is wrong to assume this will mean a severe decline in homeownership. First, as the following chart shows, in the last 30 years, interest paid by homeowners has fluctuated quite dramatically while the rate of homeownership has remained steady.</p>
<p><img src="http://reason.com/assets/mc/jtaylor/verofannie5.jpg" border="0" width="429" style="border: 0px initial initial;" height="312" /></p>
<p>In 1981, for example, interest rates were at an all-time high of 16.6 percent and the homeownership rate was 65.4 percent. In 2009, interest rates were at a nearly record low of 5 percent but homeownership held steady at 67.4 percent. The last time we had that homeownership rate was in 2000, and at that point the interest rate was 8 percent.</p>
<p>Furthermore, low down payments are a relatively recent phenomenon. In the 1980s and most of the 1990s, down payments had to be roughly 20 percent of the value of your home.</p>
<p>Finally, higher interest rates and higher down payments are not necessarily a bad thing for homebuyers. Both will incentivize new owners to keep and maintain their new property. If we have learned anything in the last decade, it&rsquo;s that redefining the American dream to mean homeownership for everyone is a very risky endeavor. Besides, the alternative to homeownership is not life on the streets, it is renting.</p>
<p><em style="font-style: italic;">Contributing Editor&nbsp;<a href="mailto:vderugy&#64;gmu.edu">Veronique de Rugy</a>&nbsp;is a senior research fellow at the Mercatus Center at George Mason University</em>. <em>This column <a href="http://reason.com/archives/2011/03/04/the-truth-about-fannie-and-fre">first appeared</a> at Reason.com.</em></p>
<p>&nbsp;</p>1011325@http://www.reason.orgFri, 04 Mar 2011 12:00:00 ESTvdereugy@gmu.edu (Veronique de Rugy)